Finding bullish divergence on a chart is going to give you insight and potentially a better entry on a stock chart. RSI is one of many momentum indicators that many traders use so lets take a look at finding divergence using RSI and see how you can apply it in the real world.
A disagreement between momentum and price can be a dangerous situation for traders. It can be akin to the goose that lays the golden egg for seasoned traders. If you got it and can spot it, you can profit.
That is of course if you know what to do with the goose when you have it. Luckily, this golden egg of opportunity is reflected in several different patterns. For today, I will focus on one form of disagreement, the bullish divergence RSI.
What Is a Bullish Divergence on A RSI?
- A bullish divergence RSI occurs when the stock makes a lower low while the RSI forms a higher high. RSI doesn't confirm the low and shows momentum is strengthening. The RSI or Relative Strength Index is a momentum indicator. You can apply this same strategy to other lower indicators, like MACD or Money Flow Indicator too.
There are many tools and indicators traders can use for stock trading. Being able to identify momentum is an integral part of trading the stock market.
However, when adding tools and indicators to help you, you don't want to over saturate your charts. Over saturated charts are messy and hard to read. As a result, you can miss moves. And no one wants to miss a good move!
In fact, some people don't want any indicators on their charts. These are typically price action traders. However, when you find a good balance of indicators, you can use things like the bullish divergence RSI to trade.
1. Let's Understand Momentum:
To better understand bullish divergence RSI, you need to understand momentum. If you think back to the most recent roller coaster you rode, it wasn't the engine that got you up, and over the steep hill, it was momentum.
You know the feeling. It’s the slow start out of the gate, up to the first hill then boom, the first drop happens. You start picking up speed, and suddenly to your astonishment, you’ve scaled that steep incline without a breeze.
All of a sudden, you drop and rise again, seamlessly navigating the circular, puke enticing loop. All the while secretly cursing your kids who talked you into this and, the person who invented the ride - they didn’t have your best interests in mind.
Luckily In the real world, incidents of injury with roller coasters are rare. Typically the coaster stays on the tracks.
This may be a shock to you but there’s no engine or steering in a roller coaster that keeps you on the track. Nope, you can thank momentum for that.
However, if something slows your momentum - like a broken cable or loose bolt, you’re in for trouble. Instead of seamlessly navigating around the corner, you fly straight off the tracks.
2. Becoming a Momentum Trader
Now, you’re probably wondering Ali, what does this have to do with trading stocks? Well, a lot. Because, if you don’t understand momentum, you can quickly run off the tracks.
If you forgot, momentum traders seek stocks that are moving significantly in one direction with high volume. These traders attempt to ride the momentum train - or roller coaster to the desired profit.
The stock price can be going up, just like the roller coaster climbing the hill, but can quickly reverse on you if you don't notice the signs.
So for today, we'll look at how divergence in momentum and price can tell you about trend direction.
Now before you forgo roller coasters for the rest of your life, the odds of dying in a roller coaster accident are relatively slim.
According to a report from the National Security Council, thrill seekers have about a 1.5-in-a-million chance of even being injured on one. but in the trading world high.
Momentum traders can use the bullish divergence RSI to their advantage. In fact, check out our courses to learn more.
3. Measuring Momentum Using the RSI Oscillator
Like a roller coaster, degree in the rise and fall shows the strength of the momentum. Or, the length of the short-term price swings. Strong momentum equals an sharp increase in price action.
Think the roller coaster at Takabisha at 121 degrees - this is not for the faint of heart. Weak momentum, on the other hand, is just the opposite. Think the Barnstormer at Walt Disney World.
All the ride talk aside, momentum and in the trading world is significant. As an oscillator, it smooths out price action to give you a clear signal if it's the right time to enter a trade. And one of the most common momentum oscillators is the RSI.
By definition, RSI is the average gain of up periods during a specified time frame divided by the average loss of down periods.
Usually, it’s over 14 trading days, and the resulting number will tell us if a reversal is imminent. It’s a pretty powerful indicator and one the savvy day trader should heed.
It measures on a percentage scale from 0 to 100 and is most advantageous when you can't see a clear trend in a company’s stock. In most instances, this would be a stock that is trading horizontally or sideways.
For each price upswing, there is a corresponding upswing in RSI. When price swings down, RSI also swings down.
How Do You Get a Bullish Divergence?
- A divergence looks for a disagreement between technical indicators and price action. A bullish divergence RSI happens when the RSI moves higher while price moves lower.
1. What Does the RSI Percentage Mean?
RSI > 70% = Overbought
What does this mean? The stock is overbought and is trading near the top of its high-low range. Thus primed for a reversal in the down direction
How to capitalize on this? This could be a great time for a short entry. Alternatively, if you’re long in the stock, it’s time to exit your position
RSI< 30% = Oversold
What does this mean? The stock is oversold and is trading near the bottom of its high-low range. Thus primed for a reversal in the up direction.
2. Divergence and Does Price Agree With Momentum?
The study of momentum checks, whether price and the indicator are going in the same direction. Do they agree or disagree?
In it’s most simple definition, divergence is when there is disagreement between a technical indicator such as RSI and price. Price is not going the direction it “should” according to the indicators.
Here’s an example below of a case where the price is rising - quite steeply for that matter, but the RSI is not. In this example, the RSI is only around 60%. The stock pulls back and starts to trade sideways and reach new support of approximately $37.
Good To Know: Technical traders generally use divergence when price moves in the opposite direction of a technical indicator. Click here for our trading service.
3. What Does It Mean When You Spot a Divergence
I’m happy you spotted it because it will help you immensely. We make the most profits when we spot divergences and act accordingly.
If you find yourself about to place a trade to the long side when the price is trending up but, the RSI or MACD (another oscillator) disagree, it’s a hard no. Do not enter the trade.
However, if you prefer to short like me, spotting divergence in a case like this is money in the bank. The golden goose has arrived.
Similarly, if you’re in a trade, exit now, take your money and run. Simply because a divergence means a high probability, something is going to happen. Perhaps its a trend or price reversal.
In the trader world, this could be called a price retracement. In some cases, it's not a full reversal but a sideways trend such as the case of Chesapeake Energy (CHK) above.
What Is RSI Buy Signal?
- The RSI is a technical indicator that measures current price strength in relation to previous stock price.It can also show when a stock is overbought or oversold.
1. What Is a Bullish Divergence RSI?
A bullish divergence is the opposite of bearish indicators. They occur when prices reach a new low, but the oscillator reaches a higher bottom or low than it previously reached. Often, these bullish divergences are the best signals of an impending sharp rally.
Not all technical indicators have a standardized extreme range like RSI does. But, the excessive ranges on RSI make it a useful indicator for this kind of analysis.
The example below is a bullish divergence. The RSI setting higher lows identify it in the lower extreme range (>30%) while the market is making lower lows.
Learn how to identify these turning points so you can turn a profit.
2. What Do I Do If I Spot a Bullish Divergence RSI?
A bullish divergence is an excellent timing signal for traders to go long in the market or to buy call options. In either case, the signal has given you valuable information.
Similarly, if the bullish divergence occurs with the RSI below 30, then bearish investors or short investors will start controlling their risk and market exposure more closely. In either case, the signal gives you valuable information.
3. Bullish Divergence RSI Key Take Aways
- Momentum indicators include the relative strength index (RSI) and MACD
- The length of short-term price swings measures price momentum
- Steep slopes with a long price swing represent strong momentum
- Weak momentum has a slight slope and short price swing.
- Divergence—the disagreement between indicator—can have significant implications for trade management
- Divergences can happen to trigger trades in both direction
- A bullish divergence RSI occurs when the RSI is making higher low
- Technical traders generally use divergence when price moves in the opposite direction of a technical indicator
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