This is my second article about RSI. In the first article, I have talked about RSI support/resistance breakout which is one of the RSI’s exceptional features: RSI Support and Resistance Breakout
In the articles we have published about MACD, it is explained what Divergence and Convergence are:
RSI also forms Divergence and Convergence which is a strong reversal signal.
Note: RSI’s default settings is 14, but the RSI settings we use here is 9.
RSI Divergence:
RSI Divergence forms when price goes up and forms higher highs, and at the same time RSI goes down and forms lower highs.
This pattern forms at the top of bull markets (uptrends), and is known as a strong reversal pattern, and usually the price changes its direction and goes down when RSI Divergence forms.
This pattern usually appears several candlesticks before the uptrend changes its direction and breaks below its support line. Therefore, like RSI support breakout which is a leading signal indicating that the price support will be broken soon, RSI Divergence is also a leading signal indicating that the uptrend will reverse soon:
Now the question is: can we go short, right when RSI Divergence forms?
I don’t do it and I don’t recommend it to you too because it is possible that the price keeps on going up and forming higher highs, even when MACD or RSI Divergence already formed on the chart. To take a short position, we need something more, like a support breakout that occurs after the RSI Divergence, or a strong candlestick pattern like a strong Bearish Engulfing or Dark Cloud Cover.
An example of RSI Divergence which is combined with a very strong bearish engulfing candlestick pattern (the red arrow):
RSI Convergence:
RSI Convergence forms when price goes down and makes lower lows, and at the same time, RSI goes up and makes higher lows. This pattern forms at the bottom of bear markets (downtrends) is also a reversal pattern indicating that the downtrend will reverse and the price will go up soon. Like RSI Divergence, RSI Convergence usually forms sooner than price reversal. Therefore, it is an early and leading signal indicating that price will go up soon.
Like RSI Divergence, we’d better not to go long as soon as RSI Convergence forms on the chart, because it is possible that the price keeps on going down and making more lower lows, even when there is RSI Convergence already formed on the chart. It is recommended to go long when another reversal setup like resistance breakout, or a strong bullish candlestick pattern like Bullish Engulfing or Piercing Line forms on the chart.
Sometimes, MACD also forms a divergence or convergence at the same time that there is RSI Divergence or Convergence. Having MACD and waiting for both RSI and MACD to form divergence or convergence at the same time will considerably lower the risks.
MACD and RSI Divergence at the Same Time:
MACD and RSI Convergence at the same time:
What about the stop loss and target?
If you go short based on RSI Divergence, then a little above the last higher high of the price is the safest place to set the stop loss. If you go short after a support breakout while there is RSI Divergence already formed, then you can set the stop loss above the high price of the candlestick that closes below the support line.
Similarly, if you go long based on RSI Convergence, then a little below the last lower low of the price is the safest place to set the stop loss. If you go long after a resistance breakout while there is RSI Convergence already formed, then you can set the stop loss below the low price of the candlestick that closes above the resistance line.
This is it about RSI Divergence and Convergence. I will publish at least one more article about some of the other RSI features.
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