To analyze stock momentum using RSI (Relative Strength Index) divergences, look for discrepancies between the RSI indicator and the stock’s price action. When the stock price is making new highs or lows but the RSI is not, it signals a potential reversal. RSI divergences are powerful tools for predicting trend changes, helping you spot overbought or oversold conditions in stocks.

What is RSI and How Does It Work?

RSI (Relative Strength Index) is a momentum oscillator that measures the speed and change of price movements. It oscillates between 0 and 100, where values above 70 indicate that a stock is overbought, and values below 30 suggest it is oversold. RSI helps traders identify potential reversal points in the market, as well as confirm trends.

What Are RSI Divergences?

RSI divergences occur when the price of a stock is moving in one direction, but the RSI is moving in the opposite direction. There are two types of divergences: bullish divergence and bearish divergence. A bullish divergence happens when the price forms lower lows, but the RSI forms higher lows, indicating potential upward momentum. Conversely, a bearish divergence occurs when the price forms higher highs, but the RSI forms lower highs, indicating potential downward momentum.

How to Spot Bullish Divergence Using RSI?

A bullish divergence occurs when the stock price is making lower lows, but the RSI is forming higher lows. This suggests that despite the price dropping, the momentum behind the stock is improving, which could lead to a reversal to the upside. A bullish divergence is a strong signal for traders to consider entering a buy position.

How to Spot Bearish Divergence Using RSI?

A bearish divergence occurs when the stock price is making higher highs, but the RSI is forming lower highs. This indicates that while the price is increasing, the momentum behind it is weakening. This divergence often signals that a trend reversal to the downside may be imminent. Traders may look for opportunities to sell or short the stock in such cases.

How Do RSI Divergences Help in Predicting Reversals?

RSI divergences are considered leading indicators because they highlight potential trend reversals before the price actually changes direction. When a divergence occurs, it suggests that the current price movement is losing strength, signaling that a change could be near. Traders use these divergences to anticipate trend shifts and make informed trading decisions.

What Are the Limitations of Using RSI Divergences?

While RSI divergences are a powerful tool, they are not foolproof. Divergences often signal potential reversals, but they do not guarantee that a reversal will happen. In some cases, the stock may continue its trend despite the divergence. It’s important to combine RSI divergence with other technical analysis tools and indicators, like trend lines, moving averages, or volume analysis, for a more accurate prediction.