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Table of Contents

Divergence Cloud Manual

What is Divergence Cloud?

Divergence Cloud is a trend and volatility based indicator and trading system designed to detect and profit off of reversals and continuations. It analyzes price, trend, momentum, and volatility to predict the most likely future price action, and then depicts its predictions on the chart with glowing clouds, colors, and entry/exit signals. 

It draws glowing areas on the chart called ‘divergence clouds’ which indicate the expected price action based on its calculations.

How it works with Trading 360

As part of the Trading 360 System, Divergence Cloud is built to capitalize primarily on reversals by predicting them before they happen. These reversals tend to come after prolonged periods of unidirectional price action.

Whereas 1-2-3-Strike! is designed to trade in the direction of the trend and Volatility Crusher to catch breakaways into new trends, Divergence Cloud is meant to signal when these trends are coming to a close or potential reversal.

It can be used synergistically as a ‘confirmation signal’ with 1-2-3-Strike! and Volatility Crusher by comparing their signals against the current cloud color, or anticipating a change of trend.

Like all of the Power Bundle 360 indicators, it is designed so that it can be used both independently or in conjunction with the other indicators.

Divergence Clouds

Bullish Divergence Clouds

Bullish divergence clouds develop around areas where volatility is stabilizing and decreasing, while price trend and momentum are accelerating upwards. These moments often indicate strong bullish support before an upward reversal, and are usually good long entry points during a pullback before bullish trend continuation. This kind of price action is also referred to as ‘grinding upwards’ – when volatility is low but the trend is steadily bullish. 

Simply put, Bullish Divergences occur when:

  • Volatility is low and decreasing
  • Price and momentum are sloping upwards

Bearish Divergence Clouds

Bearish divergence clouds develop in zones where volatility is high and increasing, while price trend and momentum are accelerating downwards. These clouds are designed to single out unsustainable tops before drops, and failing strength and support leading into downtrends. Commonly known as ‘blow-off tops’, these prime points of reversal are generally solid short entry points.

Thus Bearish Divergences occur when:

  • Volatility is high and increasing
  • Price and momentum are accelerating downwards

How is all of this calculated?

Divergence Cloud focuses on calculating volatility, price trend, and momentum. Its most important parameter is the Divergence Lookback, which determines the number of historical bars it looks back over when checking for a divergence and calculating a divergence cloud. It compares the volatility and trend conditions which existed ‘Divergence Lookback’ bars ago with the conditions of the current bar. If a divergence occurred, an appropriate cloud is drawn.

Volatility increase + downward price acceleration = Bearish divergence cloud and short entry

The ATR Period parameter sets the period of the ATR used in volatility calculations.

The Min. Price Move (in ATR %) sets a hard minimum on the absolute change in price that must occur over the divergence lookback to register a valid divergence cloud. For example, if the Min. Price Move (in ATR %) parameter was set to 200 in the screenshot above, then price would have needed to decrease by more than 2X the ATR over the divergence lookback to create the bearish cloud which generated that sell signal.

The entry and exit system

Entries

Long and short trade entries are taken when a chain of divergence clouds in a new direction begins. The trades are then held until a reversal entry occurs, or until all of the partial exits (the # is set by the parameters ‘Long Partial Exits’ and ‘Short Partial Exits’) are filled. A partial exit occurs when a ‘streak’ of consecutive clouds comes to an end. However, this isn’t always the case, as there are also built-in/proprietary time and price based formulas to prevent trades from exiting too early.

Exits

Partial, or scaled, exits are then taken whenever a streak, or chain, of clouds in the trade’s direction comes to an end. These moments indicate that initial conditions which opened the trade are coming to an end, and its best to secure some profits or cut losses. The maximum number of scaled exits taken per trade is set by the Long Partial Exits and Short Partial Exits parameters. The values of these parameters should be adjusted to fit your own position sizing and scaling preferences.

Long Partial Exits

Long partial exits occur in two cases:

  1. Price is still trending upwards from the entry, but volatility increases
  2. Price trends downwards from the entry, while volatility is still low
Long entry followed by two partial exits

Short Partial Exits

Short partial exits occur in two cases:

  1. Price is still trending downwards from the entry, but volatility decreases
  2. Price trends upward from the entry, while volatility is still high
Short entry followed by four partial exits as trend begins to stabilize and reverse

Summary

Logic

To find trades, Divergence Cloud looks back over ‘Divergence Lookback’ bars from the current bar. It then compares the volatility and trend at the start and end of this lookback period to determine if a divergence occurred.

If volatility increased over the period while trend accelerated downwards, then a Bearish Divergence Cloud is drawn

If volatility decreased over the period while trend accelerated upwards, then a Bullish Divergence Cloud is drawn

Entries are taken when the direction of the divergence clouds changes, and exits are taken when the clouds lose their strength.

Parameters

Divergence Lookback

Sets the length of the period Divergence Cloud looks back over to determine divergences.

ATR Period

Sets the period for the ATR used in calculating the volatility value. This value is compared at the start and end of the Divergence Lookback period to determine the cloud type.

Min Price Move (in ATR %)

This is a measure to help filter out flat price action. For a divergence over the lookback period to be valid, the absolute change in price over the period needs to be greater than or equal to at least this percentage factor of the ATR.

Long Partial Exits

Sets the number of partial exits the indicator will attempt to take for long trades before looking for new long entries. This is a guide for your discretionary trading depending on your sizing/how many exits you take per entry. It will affect the IET statistics.

Short Partial Exits

Sets the number of partial exits the indicator will attempt to take for short trades before looking for new short entries. This is a guide for your discretionary trading depending on your sizing/how many exits you take per entry. It will affect the IET statistics.

Trading Style

This setting limits the signaled/displayed entries and exits to either ‘Long and Short’, ‘Long Only’, or ‘Short Only’. It can help adapt the indicator to a chart’s directional bias by comparing the IET statistics for different trading styles.

Show Trigger Lines

This setting is not included or possible on all platforms. Purely cosmetic – it highlights the latest divergence cloud which triggered the entry signal.

Color Price Bars

Enabling this setting will color the price bars depending on if we are currently experiencing a bullish/bearish divergence.

Trade Examples

Divergence Cloud shorting into and then buying up a dip in NASDAQ futures on the 2 minute chart, after configuring for high efficiency with IET.

Divergence Cloud repeatedly shorting highs and buying dips with high efficiency on PTON

Platform-specific topics

For more detailed coverage and examples for all platforms, be sure to check out the Trading 360 Master Class.

MotiveWave

Scanning for Divergence Cloud signals

To scan for Divergence Cloud signals:

  1. Create a new Scan page
  2. Select ‘New Scan’
  3. Select ‘Study’
  4. Choose the Divergence Cloud study
  5. Select one of the ‘(Alert)’ plots to scan for

Usage in the Strategy Builder

Divergence Cloud can be used with our Strategy Builder for MotiveWave to create entry, exit, target, and stop conditions. To define a plot condition with Divergence Cloud:

  1. Select the desired ‘(Alert)’ plot from the first input dropdown
  2. Select ‘Greater than’ as a comparison
  3. Set the compared value to ‘Numerical’ and ‘0’

NinjaTrader 8

Creating a Custom Market Analyzer Column

A custom column can be created in the Market Analyzer to scan for signals from any of Divergence Cloud’s plots. To create a custom column:

  1. Right click inside the Market Analyzer, select ‘Columns’
  2. Select ‘Indicator’
  3. Navigate to ‘TradingIndicators -> Divergence Cloud’
  4. Select the desired plot
  5. Click ‘Ok’ – the column will appear and calculate its values

Strategy Builder

Strategies created with the Strategy Builder can incorporate Divergence Cloud signals by creating conditions like so:

  1. Add new condition
  2. Select ‘Indicators -> Divergence Cloud’
  3. Select the desired value plot
  4. Set the comparison as ‘Greater than’ a numerical value of 0 using ‘Misc->Numerical’

MetaStock

Configuring an Optimization System Test

Divergence Cloud comes with two System Tests: ‘Divergence Cloud’ and ‘Divergence Cloud – Optimizer’. The ‘Optimizer’ test allows you to configure the parameter combinations that you would like it to test while optimizing.

Each parameter can be assigned a range which you would like to test, from minimum to maximum value, as well as the increment by which you would like the parameter value to step from the minimum to the maximum.

To configure these settings for the parameters:

  1. Go to System Tests in the Power Console
  2. Navigate to ‘Divergence Cloud – Optimizer’
  3. Double click on the test to open its settings menu
  4. In the ‘Optimizations’ tab, you can configure the test values
  5. For ‘Trading Style’, a value of ‘0’ means that the test will use both long and short trades; ‘1’ will take only long trades, and ‘2’ will take only short trades

Videos