Trading Divergence and Understanding Momentum

The RSI indicator pane is shown under your chart and its line responds to the specific price action on the actual price chart. To identify bullish RSI divergences, start by finding a downtrend or a series of consecutive lower lows in the market. Next, look for a bullish divergence between the price and the RSI indicator.

Technical traders generally use divergence when the price moves in the opposite direction of a technical indicator. There must be price swings of sufficient strength to make momentum analysis valid. Momentum is therefore useful in active trends but it isn’t useful in range conditions in which price swings are limited and variable as shown here in Figure 4. Price swings aren’t always easy to evaluate with the naked eye because the price can be choppy. Momentum indicators are commonly used to smooth out the price action and give a clearer picture.

It may be primed for a trend reversal  or corrective price pullback. An RSI reading of 30 or below indicates an oversold or undervalued condition. If you use some extra technical tools on your chart, you may get a more precise exit signal for your trades. Also, don’t forget that you can always use the overbought/oversold signals of the RSI itself.

  1. The strategies can also be optimized using algorithms that can be accessed using trading tools available easily on the net.
  2. The indicator shows overbought or oversold conditions in the price of an asset as it swings up and down within its indicator box.
  3. However, that’s not always the case, as the instrument and the indicator sometimes tend to move in the opposite direction.
  4. Fortunately, there are only few variables that should be taken into account for a valid divergence signal.

Here, we can see that the RSI formed lower lows at the same time the price formed higher lows. The period of divergence occurred at the time that price was pulling back in a retracement move. Usually divergence is hidden and not immediately obvious until it has occurred. Such tools include the Fibonacci retracement tools, which are able to detect the exact pullback levels and match them with the higher lows formed by the price bars/candles. A hidden bullish divergence is a setup where the oscillator forms progressively lower lows at the same time that the price is forming higher lows.

Momentum Indicator (MOM): Full Guide

The higher low in the RSI does not have to be in the oversold area for the signal to be valid. Now let’s take a closer look at some examples of rsi divergence and how you can use it to identify potentially profitable trading opportunties. Traders should test and optimize their RSI divergence strategy for each asset they trade. RSI divergence can be used for any asset that has a price and an RSI indicator. RSI divergence is just one tool among many in a trader’s toolkit.

Conversely, an RSI that dips below the horizontal 70 reference level is viewed as a bearish indicator. Since some assets are more volatile and move quicker than others, the values of 80 and 20 are also frequently used levels for overbought and oversold assets. The most common instance when divergence fails, is in strongly trending markets. If you take too many divergence trades in a strong trend, you will lose a lot of money. In other words, it helps traders spot potential price reversals.

Are Candlestick Patterns Reliable

The accumulation distribution indicator (ADL) is a volume-measurement kind of indicator. This begins with establishing a trading plan and back-testing your plan. Then if your technique passes those tests, you can move into beta testing. Don’t change methods simply because you have a losing streak. Those are problems basically related to your trading psychology and trading process. Therefore, if you have a trading technique that has an edge and you’re on a losing streak, then it is time you looked at your process and psychology.

The Difference Between RSI and MACD

As a result, the stop loss order to avert the risk of incurring losses on price changing course and moving lower was placed a few pips below the lowest level. Hidden bearish divergence occurs when the price makes a lower high while the RSI makes a higher high. It indicates a potential continuation of a downtrend after a price rally. Traders can identify RSI divergence by comparing price swings and RSI movements. Divergence occurs when the price makes higher highs or lower lows while the RSI does the opposite. The RSI divergence signal is generated when the price swings and the indicator movement are no longer in phase.

Stochastic Oscillator: Full Trading Guide

The orange lines on the chart mark the higher tops and the higher bottoms of the price action. And the orange lines on the RSI indicator mark a negative divergence, shown by the RSI. You should always use a stop loss order when trading RSI divergence. Since you will get some fake signals, it is good that you stay protected during any bad trades. The price action closes higher highs and higher lows, while the RSI indicator does the opposite – lower lows and lower highs, confirming a negative divergence.

Near a resistance level, traders should watch out for bearish divergence, and near support levels, traders should look out for bullish divergence. Some traders consider it a buy signal if a security’s RSI reading moves below 30. This is based on the idea that the security has been oversold and is therefore poised for a rebound. However, the reliability of this signal will depend in part on the overall context.

In the chart above, areas of bullish reversal are indicated in green in the RSI indicator. The price tends to bounce back and increase after the initial sell-off whenever the RSI reading is at around 20. Usually, the RSI indicator line swings up and down in sync with the price swings. However, there are times when the price movement and the indicator movement are not in phase. We can see that the bearish divergence MACD setup requires the identification of two progressively lower peaks on the MACD indicator line.

Sometimes this might be just a short-term reversal of a prior impulse. You will need to decide for yourself what the most suitable exit point on the chart is. You should stay in the trade as long as you confirm that the price is moving in your favor.

These 50-line crossovers can signal a great time to enter a trade on the pull-back. This means that if the downtrend is unable to reach 30 or below and then rallies above 70, that downtrend is said to weaken. The real benefit of trading that most people miss is that it’s one of the most direct paths to deep personal development. This starts with creating a trading plan and backtesting your plan. Then if your strategy passes those tests, you can move into beta testing…and if that works out, then to live trading.


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