This article combines the edge that comes from using the Renko charts and explores the idea on how to pick better entries (dips and rallies in a trend) staying within a trend following method. In this first article, we define the common issues faced with picking the dips and rallies and also explore the advantage of divergences that are a common occurrence in the markets and how we can exploit these simple points while analyzing the financial markets.
Trend Following – Buying dips and rallies
Renko charts undoubtedly offer a unique glimpse into trends compared to the more widely used line, bar or candlestick charts. The distinctive advantage comes from the fact that Renko charts focus entirely on price movements than time and therefore tends to be more reliable in terms of selling rallies in a downtrend or buying the dips in an uptrend.
Trend following strategies are often considered to be one of the safest ways to trade. Besides the fact that an established trend simply reflects the large positioning in the instrument or market, the chances of a trend based set up going wrong are much lesser than fading the trends.
But there comes a big problem. How do you know a dip has been formed and that price will rally or how can traders be convinced that a rally in a downtrend has completed the correction?
Traditional traders tend to use different approaches such as looking at candlestick patterns or support and resistance levels. But truth be told, this is largely a subjective matter and if one can put two or more traders to scrutinize the same chart, chances are that one can get to see a completely different set of support and resistance levels.
So how does one avoid these discrepancies and build a more objective approach to picking the dips and rallies?
Introducing divergence trading
Divergence trading is nothing new and if you have been around in the markets for a while, one would have often come across this term. Divergence, at its simplest definition is when price action fails to validate the move in relation to another instrument, or more commonly to an oscillator.
When price makes new highs but the oscillator fails to do so (and vice versa for lows) it presents a scenario of divergence which points to a possible correction to the trend (from which arises the dips and rallies).
The concept of divergence in itself is often a misunderstood factor, especially the regular bullish and bearish divergences. For traders who want to explore this further, Andrew Cardwell’s research on RSI and more importantly the points about divergences offers some unique and great insights which can help traders to clear their minds of any misconceptions commonly found in divergence.
Without going too much into detail, a regular bullish and bearish divergence merely point to a correction in the trend, which results in the dips (during an uptrend) and rallies (during a downtrend). When this divergence is complete, the prevailing trend resumes.
The benefit that comes with using Renko Charts to spot divergence is based on the pure structure and the construction of the Renko chart itself. Because price is the only variable on the chart, trends are clearer on the Renko chart than using the Candlestick/Line or OHLC Bar charts.