How to properly use the RSI Indicator to trade. Divergence Explained. RSI, MACD, Stochastic
As the trends of the market are comprised of an array of price momentums. Oscillators and Indicators play a pivotal role in assessing the strength of the market trend. This applies to stocks, gold, crypto, and to whatever your trading asset is. Less momentum not always leads to price reversal and higher momentum does not always lead to growth. But they definitely indicate change, bearish and bullish patterns are always observed. So, whether to buy the chips or sell the dips also depends upon the divergence of the market trends as explained in the video. To elaborate further on the techie side of the market, you have to get the terminologies right. So, please don’t have to rush to the search engine and refer to the below:
Oscillators& Indicators-RSI, MACD, StochasticAn oscillator is a technical analysis tool that constructs high- and low- bands between two extreme values, and then builds a trend indicator that fluctuates within these bounds. Traders use the trend indicator to discover short-term overbought or oversold conditions. Examples- MACD and Stochastic
1. MACD-The Moving Average Convergence/Divergence indicator is a momentum oscillator primarily used to trade trends. Although it is an oscillator, it is not typically used to identify overbought or oversold conditions. It appears on the chart as two lines that oscillate without boundaries. The crossover of the two lines gives trading signals similar to a two moving average system.
2. Stochastic– George Lane developed stochastics, an indicator that measures the relationship between an issue’s closing price and its price range over a predetermined period of time. To this day, stochastic is a favored technical indicator because it is easy to understand and has a high degree of accuracy in indicating whether it’s time to buy or sell a security.
The difference in oscillators and indicators –
Oscillators can remain at extreme levels (overbought or oversold) for extended periods, but they cannot trend for a sustained period. In contrast, a security or a cumulative indicator like On-Balance-Volume (OBV) can trend as it continually increases or decreases in value over a sustained period of time.
Indicators-A momentum indicator (oscillator) is a technical indicator that shows the trend direction and measures the pace of the price fluctuation by comparing current and past values. It is one of the leading indicators that measure the rate of change of securities. A momentum indicator is generally used in unison with other indicators. Example RSI
RSI-The relative strength index (RSI) is a momentum indicator used in technical analysis that measures the magnitude of recent price changes to evaluate overbought or oversold conditions in the price of a stock or other asset.
DivergenceDivergence is when the price of an asset is moving in the opposite direction of a technical indicator, such as an oscillator, or is moving contrary to other data. Divergence warns that the current price trend may be weakening, and in some cases may lead to the price changing direction.
There are two types of divergences: Regular divergence and hidden divergence. Each type of divergence will contain either a bullish bias or a bearish bias. Bullish and bearish patterns of both the divergence are explained as:
Regular Divergence– Regular divergences signals a possible trend reversal. That means a bullish rally will change to decline and a bearish decline will uptrend into a rally.
1. Bullish Bias– When the price momentum is Lower Low and Momentum oscillator is Higher Low. It indicates the underlying strength of the asset, Bears are exhausted. It is a warning of a possible trend direction change from a downtrend to an uptrend. Buy the shares.
2. Bearish Bias –When the Price momentum is Higher High and the momentum oscillator is Lower High, It Indicates the underlying weakness of the asset which means, Bulls are exhausted. It is a warning of a possible trend direction change from an uptrend to a downtrend. Sell the shares
Hidden Divergence– Hidden divergences signal a possible trend continuation. That means a bullish rally will continue to uptrend and a bearish trend will continue to decline.
1. Bullish Bias-When the Price momentum is Higher Low and the momentum oscillator is Lower Low. It indicates underlying strength. The asset is here to stay. This occurs during retracements in an uptrend. Nice to see during the price retest of previous lows. Buy the shares.
2. Bearish Bias –When the Price momentum is Lower High and the momentum oscillator is Higher High. It indicates an underlying weakness. Found during retracements in a downtrend. Nice to see during price retests of previous highs. Sell the shares.
Oversold and overbought
The Relative Strength Index (RSI) describes a momentum indicator that measures the magnitude of recent price changes to evaluate overbought or oversold conditions in the price of a stock or other asset. Originally developed by noted American technical analyst J. Welles Wilder Jr., who introduced the concept in his seminal 1978 book, “New Concepts in Technical Trading Systems, “1 the RSI is displayed as an oscillator, which is a line graph that moves between two extremes. Its reading can range from 0 to 100.
The primary trend of the stock or asset is an important tool used to ensure that the indicator’s readings are properly understood. Well-known market technician Constance Brown has widely promoted the idea that an oversold reading on the RSI that occurs in an uptrend is likely much higher than 30%, and an overbought reading on the RSI that occurs during a downtrend is much lower than 70%.
Traditional interpretation and usage of the RSI dictate that values of 70 or above suggest that a security is becoming overbought or overvalued and may be primed for a trend reversal or corrective price pullback. An RSI reading of 30 or below indicates an oversold or undervalued condition.
Example of bullish and bearish divergence
1. Regular Bearish Divergence
If you refer to the bitcoin in July 2020, you will see that it made a higher high, a very nice rally, in fact, a very violent uptrend and probably you gained some nice profits. If you look at the RSI you will see that the RSI were at an overbought level and for In the same period we actually made a lower high, so this is Divergence, this the price made a higher high and the RSI made a lower high also note Bitcoin was overbought and you’re like okay I will make a decision and I’m going to sell but look how much further we rallied thereafter right, you know right after it was declared overbought we went up a thousand dollars thereafter. So what does this divergence mean well if the price made a higher high and the RSI made a lower high this is called a bearish divergence, a regular bearish divergence, and what this indicates is that in a rally we are losing momentum meaning look for a price reversal up ahead and what happened after this divergence was spotted the price did the reverse and we actually crashed pretty hard all the way down to below 6,000 eventually a month?
2. Regular bullish divergence
You will see that the price of Bitcoin in June 2020, the price made a lower low and if we take a look at the RSI, the RSI made a higher low this is classic bullish divergence .one is going down and one is sloping upward now you want to try to find a confluence between the other indicator as well and if we take a look at the stochastic you’ll see that it is trending the same way as the RSI showing the same divergence for the same period against the price right the stochastic made a higher low. So, this signifies that there is a possible reversal up ahead right so we’re in a downtrend that there is a possible reversal up ahead and you’ll see that we went the price went from 5800 which was a low here to eventually hitting around 8400 or 8350.
To use a momentum indicator correctly it is necessary to know the strategy to follow. The price will always lead the way but momentum will indicate the time to preserve the profits and prevent the losses. As you can see divergence often gets neglected but plays a very important role in market analysis.