RSI Divergences - Educational Piece

How To Spot Them?

In the realm of technical analysis, the Relative Strength Index (RSI) is a mainstay among traders who seek to gauge the momentum and potential reversal points in price trends. This is a setup we often use, especially for Cryptos and Commodities, which are usually more respectful of such technical setups relative to the equity market. However, with other technical indicator confirmations, these divergences work like a charm on most occassions!

Divergence occurs when the price of an asset moves in the opposite direction of a technical indicator, and in the case of RSI, this can be a powerful signal suggesting either a potential trend reversal (regular RSI divergence) or a continuation (hidden RSI divergence). This article delves into 4 types of RSI divergence: Bullish RSI Divergence, Bearish RSI Divergence, Hidden Bullish RSI Divergence, and Hidden Bearish RSI Divergence.

1. Bullish RSI Divergence (Bullish Reversal)

Bullish RSI Divergence is considered a signal that the current downtrend may be weakening and potentially reversing to the upside. It occurs when the price records a lower low, but the RSI forms a higher low. This indicates less downward momentum, suggesting that the sellers are getting exhausted, and a trend reversal to the upside may be imminent.

It’s important to remember that multiple drives of bullish RSI divergence can be formed if price makes lower lows more than once, but the RSI makes a higher low during price action’s lower low.

2. Bearish RSI Divergence (Bearish Reversal)

Bearish RSI Divergence signals that an uptrend may be running out of steam and could reverse to the downside. This form of divergence occurs when the price makes a higher high, but the RSI makes a lower high. This divergence can be an early warning that while prices are climbing, the upward momentum is weakening.

Remember, like multiple drives of bullish RSI divergence, there can also be multiple drives of bearish RSI divergence as price makes more than one higher high, while the RSI continues to make lower highs.

3. Hidden Bullish RSI Divergence (Bullish Continuation)

Hidden Bullish RSI Divergence is a hint that the current uptrend will continue. It occurs during a retracement in an uptrend where the price makes a higher low, but the RSI makes a lower low. This suggests that despite a lot of pressure from the bears, the bullish price momentum is still strong, and the overall upward trend is likely to resume. The concept of multiple drives of hidden bullish RSI divergence also applies here.

4. Hidden Bearish RSI Divergence (Bearish Continuation)

Hidden Bearish RSI Divergence indicates that a downtrend is likely to continue. This occurs during a retracement in a downtrend, where the price makes a lower high, but the RSI makes a higher high. This type of divergence suggests that even though the bulls tried hard, the overall bearish sentiment remains dominant as price failed to follow suit. The concept of multiple drives of hidden bearish RSI divergence also applies here.

RSI divergence can be a cornerstone for those who follow technical analysis, providing insights into potential price movements before they occur. Whether it's signaling a reversal or a continuation, understanding these 4 types of RSI divergences can enhance a trader’s ability to trade the market. As with all trading strategies, there are occasions when the divergence gets burned through and price does not reverse/continue. However, from a probability standpoint, the numbers are in your favor while playing divergences as far as you maintain solid risk management.

Let us know if there are any other topics you would like us to cover in our Educational Piece. Until next time!

Disclaimer - All materials, information, and ideas from Cycles Edge are for educational purposes only and should not be considered Financial Advice. This blog may document actions done by the owners/writers of this blog, thus it should be assumed that positions are likely taken. If this is an issue, please discontinue reading. Cycles Edge takes no responsibility for possible losses, as markets can be volatile and unpredictable, leading to constantly changing opinions or forecasts.