RSI Divergence Trading Strategy

How to trade an RSI divergence (with example) →

Hey there,

Happy New Year ✨

Imagine you want to buy a car and talk to one of your friends who is a car dealer. They enthusiastically promote a model highlighting its features and the price fits your budget too. On the other hand, another friend of yours who owns the car tells you about their bad experience with it. While your dealer friend is advising you to get the car, your friend who owns the car is recommending you avoid it. Whom will you listen to?

Well, in trading, a ‘divergence’ is a similar problem.

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Let’s get back to today’s issue!

What is a Divergence?

A divergence occurs when the price of a stock and a technical indicator give contradictory signals about the stock’s potential future movement. For instance, a bullish engulfing pattern forming on the chart suggests an uptrend, but if the RSI signals a pullback from the overbought territory, indicating a potential correction, it creates a divergence.

A positive divergence occurs when a stock’s price is moving lower but an indicator is showing bullish signals. Conversely, a negative divergence occurs when a stock’s price is moving higher but an indicator is showing bearish signals.

Navigating a Divergence in RSI (with example)

The solution to interpreting a divergence is simple - focus on the basics, i.e. price action. It is necessary to understand that an indicator is ultimately a kind of derivative of the price. Hence, always rely on price movements during a divergence.

Let’s understand this with an example ⬇️

Positive Divergence

A positive divergence occurs when the price is making Lower Lows (bearish), but the RSI is making Higher Lows (bullish).

> Don’t follow the RSI, i.e. don’t buy until the price gives a buying signal in the form of a bullish pattern or a breakout.

You can see how a divergence occurred (marked by black trendlines), but a confirmation for entry was given when a bullish candle was formed (where open=low), triggering an uptrend.

Negative Divergence

A negative divergence occurs when the price is making Higher Highs (bullish), but the RSI is making Lower Highs (bearish).

> Don’t follow the RSI, i.e. don’t sell until the price gives a sell signal in the form of a bearish pattern or a breakdown.

You can see how a divergence occurred (marked by black trendlines), but a confirmation for selling was given when a long bearish candle was formed (where open=high), triggering a downtrend.

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