Understanding the RSI Divergence
17th Nov • 3 min read
Table of Contents
Relative strength index (RSI) is a popular technical indicator used by traders to analyse the strength of a security’s price action. It compares the magnitude of recent gains to recent losses to determine if a security is overbought or oversold. The RSI values range from 0 to 100, with values above 70 indicating overbought conditions and values below 30 indicating oversold conditions.
RSI divergence occurs when the direction of the RSI differs from the direction of the price of an asset. In other words, while the price of the asset is moving in one direction, the RSI is moving in the opposite direction. Divergence can be either bullish or bearish, depending on the direction of the price and RSI.
Bullish divergence occurs when the price of the asset is making lower lows, while the RSI is making higher lows. This can be an indication that the asset may be oversold and ready for a price reversal, as the RSI is showing increasing strength while the price is declining. This can be a sign that the downward trend in price may be losing momentum, and that buyers are starting to return to the market.
Bearish divergence, on the other hand, occurs when the price of the asset is making higher highs, while the RSI is making lower highs. This can be an indication that the asset may be overbought and ready for a price reversal, as the RSI is showing decreasing strength while the price is rising. This can be a sign that the upward trend in price may be losing momentum, and that sellers are starting to return to the market.
It’s important to note that RSI divergence is not a standalone trading signal, and should be used in conjunction with other technical analysis tools and fundamental analysis to make informed trading decisions. Additionally, RSI divergence can be a subtle and early warning sign of a trend reversal, so it’s important to confirm any potential divergences with other technical indicators or analysis before making a trade.
One way to confirm a potential RSI divergence is to look for other technical analysis that may be showing similar signals. For example, if you see a bullish RSI divergence, you may want to look for other indicators that are also showing bullish signals, such as a break of structure or a Supply or Demand zone support the trade direction. You could also look for a ChoCh, as a ChoCh can sometimes confirm a trend reversal.
It’s also important to consider the overall market trend when analysing RSI divergence. If the market is in a strong uptrend, for example, it may be more difficult for bearish divergence to signal a trend reversal, as the uptrend may be strong enough to continue despite the bearish divergence. On the other hand, if the market is in a strong downtrend, bullish divergence may be more likely to signal a trend reversal.
It’s also important for traders to keep in mind that RSI divergence is not a perfect indicator and may not always signal a trend reversal accurately. There may be false signals, or the divergence may not be strong enough to indicate a trend reversal. In these cases, traders may want to use additional tools and analysis to confirm any potential divergences.
Overall, RSI divergence can be a useful tool for traders looking to identify potential trend reversals. However, it’s important to use it in conjunction with other technical analysis tools and considerations, and to confirm any potential divergences with other indicators before making a trade. As with any technical indicator.