RSI divergence can be a useful way to spot which direction the market may be heading and doesn’t need to be complicated. Once you know how to spot RSI divergence on your charts, it will only take a few seconds and can be another useful filter for your technical analysis. I will show you how to spot RSI divergence in a very easy way and use it to your advantage.
What is the RSI indicator?
The Relative Strength Index (RSI) indicator is a very popular tool used for technical analysis. It can show overbought and oversold levels between 0 to 100. The majority of traders will consider the market to be overbought if price is above 70 and oversold if the price is below 30. Because so many traders follow these levels, they can have a self-fulfilling prophecy.
What many beginners do not know, is that the RSI indicator can also be a great way to find market trends via divergence. When you combine the RSI extreme levels to try and spot overbought/sold markets with an understanding of divergence, you have one of the most powerful yet easy to use technical analysis tools available.
What is RSI divergence?
When the RSI indicator is showing divergence in one direction but the market is heading in another, it can often be a sign that things are about to change. This can allow traders to spot new trends and get in them at the beginning. RSI divergence can also be used to manage open positions. If you spotted some divergence that suggested the market was about to turn around, it could be a good time to think about exiting the position.
How to spot RSI divergence
You are simply looking for the RSI indicator to make higher lows for a possible uptrend or lower highs for a possible downtrend. The more times it does this, the stronger the signal might be. The divergence signal can be considered even stronger if it occurs in the extreme zones of above 70 for a sell trade or below 30 for a buy trade. It really does not need to be made more complicated than that. Once you know what RSI divergence is, it is really easy to spot on your charts.
Bullish RSI divergence
You can see from the chart that the RSI was below 30 suggesting an oversold market but starting to climb up and making higher lows whilst the market was still falling. This is showing bullish divergence and the potential for the market trend to turn around.
Bearish RSI divergence
In this chart, the RSI is above 70 which suggests the market is overbought and may soon be turning around. This is confirmed by the RSI making lower highs whilst the market is still going up. This shows bearish divergence and a possibility for a downtrend to commence shortly.
How to trade with RSI divergence
One of the easiest ways to trade RSI divergence is to look for signals that also coincide with the extreme levels of the RSI indicator.
- Sell trade: RSI making lower highs and overbought above the 70 level.
- Buy trade: RSI making higher lows and oversold below the 30 level.
What are the best RSI settings for divergence trading?
I find the default RSI settings with a period of 14 and extreme levels of 30/70 to work quite well. If you decrease the period, there will be more signals but they might not be as reliable. If you increase the period there will be less signals but they may be stronger. It depends on your trading strategy and risk preference.
Which timeframe is best for RSI divergence trading?
This also depends on your trading style but I find the 1-hour charts and above to be more reliable as they help filter out some of the noise that you can get on the lower chart timeframes. This does mean that there are less divergence signals but they can be more reliable as they cover a greater amount of market data and are generally more noticeable.
RSI divergence Pros & Cons
Pros
- Identify new market trends
- Combine with extreme levels for early entry
- Can be used for entry and exit points
- Easy to spot on your charts
Cons
- Only based on technical analysis
- Market will not always turn around
- Can be open to interpretation
- Works better when combined with other indicators
Conclusion: does RSI divergence work?
Yes, trading with RSI divergence can be very powerful when done correctly. You will be able to spot trends forming and coming to an end like you wouldn’t be able to without it. This can be used to enter and exit positions at the ideal price points. However, I do feel like divergence trading works best when combined with additional market analysis to confirm signals.
Self-confessed Forex Geek spending my days researching and testing everything forex related. I have many years of experience in the forex industry having reviewed thousands of forex robots, brokers, strategies, courses and more. I share my knowledge with you for free to help you learn more about the crazy world of forex trading! Read more about me.
