10. ASSEST DIVERGENCE (SMT DIVERGENCE)

Asset Divergence Overview

  • Definition: Asset divergence, referred to as S and T divergence by the ICT community, occurs between the highs/lows of two assets that share the same quote currency.
  • Base and Quote Currency: The first part of a currency pair is the base currency (e.g., silver, gold), while the second is the quote currency (e.g., USD).

Importance of Asset Divergence

  • Identifying Reversal Points: Divergence is used to identify potential reversals in a lagging asset where a more popular asset has moved in a different direction.
  • Example: If silver is showing signs of a reversal while gold is lagging (not making a new high or low), silver can be considered the leading asset and gold the lagging one.

How to Trade Using Asset Divergence

  • Execution Strategy: Execute trades on the more popular asset (e.g., gold) when the less popular asset (e.g., silver) indicates divergence.
  • Utilizing RSI: When the Relative Strength Index (RSI) indicates divergence—lower lows in price but higher highs in RSI—this signals a potential reversal.

Practical Trading Scenarios

  • Example Setup:
  • Silver shows lower highs, while gold shows higher highs. Allows for a short position on gold.
  • Setup requires comparing highs and lows on a 5-minute chart.
  • Assessing Market Conditions: Key trading times usually between 6 AM and 11 AM CST for better liquidity and volatility.

Recognizing Divergence Patterns

  • Visual Cues: Be on the lookout for visible shifts in asset price behavior in tension with the RSI, which may not always correlate with movement of price.
  • Common Examples:
  • Silver vs. Gold (both precious metals).
  • NASDAQ vs. S&P 500 (SPX is more popular).
  • GBP vs. EUR (considering correlations between currencies).

Clarifying Terminology

  • Base Asset: The asset from which you're observing divergence.
  • Execution Asset: The asset on which you execute trades based on divergence signals.

Key Takeaways for Effective Trading

  • Watchful Execution: Quick real-time monitoring during key trading sessions can maximize potential gains from divergence setups.
  • Repeatable Systems: Establish a consistent trading system based on asset divergences to enhance return rates over repeated trades.
  • Trace Back History: Utilize past data to confirm trends and potential successful setups where divergence was profitable.

Conclusion

  • Importance of Education: Mentorship and online resources (videos, case studies) are essential for understanding and executing asset divergence strategies effectively.
  • Continual Learning: Regular reviewing of strategies and employed methodologies is critical for maintaining trading proficiency.