How to identify the trend
The oscillator plots two moving averages to display the trend direction. If the fast moving average is above the slow moving average, the market is during an uptrend and long trades can be taken. Likewise, if the fast moving average is below the slow moving average, the market is during a downtrend and short trades can be taken.
Other way to identify the market trend is by using the absolute value of the histogram. If the histogram value is above zero, the market is in an uptrend. If the histogram value is below zero, the market is in a downtrend.
How to identify the trend strength
The trend strength (or speed) is illustrated by the histogram. A blue bar stands for bullish momentum and a red bar stands for bearish momentum. What to do with this information at any given moment depends on the market trend. If bullish momentum appears during a downtrend, it means that the downtrend is exhausted and has stopped accelerating. Likewise, if bearish momentum appears during an uptrend, it means that the uptrend is exhausted and has stopped accelerating.
Automatic divergence detection
The oscillator auto-detects and plots regular and hidden divergences, and while all of them can be traded, they are not meant to be traded right away. To trade divergences successfully you have to put together the trend direction and strength, explained above. The following is the perfect situation for a bearish divergence:
- The fast moving average of the oscillator is above zero
- The oscillator displays an uptrend (fast ma > slow ma)
- The oscillator displays bearish momentum (red histogram)
- The oscillator detects a bearish divergence
Likewise, the following is the perfect situation for a bullish divergence:
- The fast moving average of the oscillator is below zero
- The oscillator displays a downtrend (fast ma < slow ma)
- The oscillator displays bullish momentum (blue histogram)
- The oscillator detects a bullish divergence
When one of these two scenarios is met, please don't enter the market automatically. You have to wait until a price action signal confirms that the market is ready to reverse. In other words, you must wait for the market to move first.