Craving more certainty from your supply and demand trades?
Confirming supply or demand zones usually involves looking for confluence or assessing the zone’s strength using market sentiment and technical factors.
Both methods work fine, but another tool to add to your arsenal:
Divergence.
Specifically, I’m talking about confirming zones using MACD divergence. Identifying instances where price and the MACD show opposing market signals. Incorporating the MACD adds an extra layer of confirmation to your S&D trades and helps you anticipate reversals with greater accuracy.
Intrigued?
Let’s dive in.
Divergence: The Hidden Signal That Confirms Your Supply and Demand Zones
You’re probably wondering:
What is divergence, and how does it work?
Divergence occurs when the price action of a currency moves in one direction, while a technical indicator, such as the Relative Strength Index (RSI) or Moving Average Convergence Divergence (MACD), moves in the opposite direction. This discrepancy often signals a potential reversal, as it suggests a weakening of the prevailing market sentiment and trend.
EUR/USD Bullish Divergence: The RSI (Relative Strength Index) printed higher highs while the market price formed new lower lows, indicating bullish momentum is building despite price falling.
Anytime there’s a mismatch between what the indicator shows and the current price action, it suggests a potential shift in momentum is brewing beneath the surface. In this case, bullish momentum was building even as new lows formed, hinting price reversal might be imminent, which indeed occurred.
Use the MACD to identify divergence and confirm supply and demand zones.
- Price prints a new high, but the MACD forms a lower high = bearish divergence.
- Price forms a new low, but the MACD forms a higher low = bullish divergence.
In both scenarios, divergence suggests a reversal is on the horizon.
Divergence is a potent reversal signal on its own, but it truly shines when used as a secondary confirmation alongside supply and demand zones.
Seeing divergence as price returns to a zone can be a strong indicator the zone has a high probability of causing a reversal.
Consider the supply zone below:
In this scenario, price just moved into the 15 minute supply zone, making a new higher high in the process. But what’s the MACD up to?
Price made a new high, but the MACD created a lower high.
That’s bearish divergence, my friend!
That’s a clear sign the market price and the average price (MACD) are out of sync, hinting a bearish reversal might be brewing behind the scenes. This mismatch confirms the supply zone holds a high-chance of reversing the current short-term uptrend back into a bearish downtrend.
Just as the new high forms, price starts heading south.
Watching for MACD Divergence can give you a early heads-up, allowing you to anticipate reversals from zones and potentially catch trades earlier than others.
Pro Tip: See how price spiked the 0.76000 level before reversing? Combining supply & demand zones, divergence, and psychological levels can significantly enhance their reversal odds, enabling you to find powerful zones long before other traders.
Confirming Zones Using Divergence: Quick Guide
Confirming supply and demand zones with MACD divergence is surprisingly simple.
It just takes a few quick steps:
- Locate your zone: Identify a potential supply or demand zone on your chart.
- Add the MACD indicator: Apply the MACD to your chart to see divergence.
- Watch for the signal: Look for divergence between the price action and MACD.
Let’s walk through a real example to see this in action.
Step #1: Add The MACD Indicator To Your Chart Window
Find the MACD under the ‘Indicators’ tab on TradingView, or via the ‘Insert’ tab on MT4/5.
For Tradingview Users: The default MACD indicator is inside in the ‘Indicators’ tab. Click ‘Technicals’, then scroll until you see Moving Average Convergence Divergence (MACD).
Keep all MACD indicator settings on default.
For MT4/5 Users: Hover over the “Insert” tab and move your cursor over indicators. Now, find “Oscillators” and click “MACD” to add the indicator to your chart.
Step #2: Check For MACD Divergence At Your Zone
Divergence happens when the MACD and price move in opposite directions, printing opposing highs and lows due to the difference in price momentum.
- Bullish Divergence: Price makes a new low, but the MACD forms a higher low.
- Bearish Divergence: Price makes a new high, but the MACD forms a lower high.
How does this translate to confirming supply and demand zones?
Simple:
- When price is rising into a SUPPLY zone – look for BEARISH divergence.
- When price is falling into a DEMAND zone – look for BULLISH divergence.
Here’s an example…
Just after the new higher high formed, the MACD printed a lower high.
Hello, bearish divergence!
The MACD and market price are showing conflicting signals, hinting a reversal might be in the works. The MACD (i.e., the average price) and the actual price are diverging, suggesting bearish momentum (supply) is growing behind the scenes and may overwhelm bullish price action (demand).
And where’s a prime spot for the reversal to begin?
You got it – the supply zone!
Let’s keep our eyes peeled for an entry signal…
Step #3: Divergence Confirmed? Time to Enter…
You still need to wait for a price action signal within the zone.
Look for a pin bar with a standout wick or an engulfing pattern with a beefy second candle (yeah, that’s the engulf). These patterns always indicate smart money activity at the zone, which raises the chance price will reverse upon return.
Price moves into the supply zone, and a bearish engulfing pattern forms. This confirms smart money selling within the zone, boosting the odds of a bearish reversal.
What happens next?
Enter a sell trade, then place your stop-loss just above the high of the engulfing pattern.
Price soon tanks, and a profitable downtrend begins.
That’s the power of using MACD divergence – it adds another layer of entry confirmation to your supply and demand zones.
The potential of this supply zone was clear, but the divergence acted as a validation signal, giving us that extra confirmation to execute the short trade. Incredibly valuable in helping anticipate reversals and enter trades at optimal points.
Divergence tells us underlying market sentiment is shifting, even when the price action hasn’t fully caught up yet.
The Bottom Line
While zone strength and confluence are helpful for confirming supply and demand zones, divergence offers an extra layer of assurance.
By revealing potential shifts in momentum, divergence increases the likelihood of a supply and demand imbalance (and a potential reversal) occurring at your chosen zone. This gives you a significant edge, allowing you to both anticipate and capitalize on high-probability trading opportunities before most other market participants.