Besides the RSI scores of 30 and 70 - which may suggest potentially oversold and overbought market conditions - traders also make use of the RSI to try and predict trend reversals or to spot support and resistance levels. Such an approach is based on the so-called bullish and bearish divergences.
A bullish divergence is a condition where the price and the RSI scores move in opposite directions. So, the RSI score rises and creates higher lows while the price falls, creating lower lows. This is called a "bullish" divergence and indicates that the buying force is getting stronger despite the price downtrend.
In contrast, bearish divergences may indicate that despite a rise in price, the market is losing momentum. Therefore, the RSI score drops and creates lower highs while the asset price increases and creates higher highs (see image below).
Keep in mind that RSI divergences are not that reliable during strong market trends. This means that a strong downtrend may show many bullish divergences before the actual bottom is finally reached. Because of that, RSI divergences are better suited for less volatile markets with prices trading in ranges or having weak trends.
Closing thoughts on RSI divergence
There are several important factors to consider when using the Relative Strength Index indicator, such as the settings, the score (30 and 70), and the bullish/bearish divergences. However, one should always keep in mind that no technical indicator is 100% efficient - especially if it is used alone. Therefore, traders should consider using the RSI indicator along with other indicators in order to avoid false signals.
Useful Stuff
Download your RSI divergence indicator HERE
Comments