Master RSI: Effective Methods to Spot Divergence and Convergence

The Relative Strength Index (RSI) enjoys high acceptance among crypto traders, and it is not by luck or simply a popular choice for beginners.

The RSI is a professional indicator distinguished by its mathematical approach while preserving simplicity, making it of great versatility as any other.

In the following sections, we will explore popular techniques using RSI for convergence and divergence signals.

Relative Strength: Understanding RSI Calculation

The RSI carries three inside components working together to calculate the Relative Strength (RS) of price movements of a crypto asset. This calculation is the key to the effectiveness of RSI despite its simplicity as a technical tool.

The relative strength of the movement of cryptocurrencies gives insights into what could be going on in the market and what to expect for the consequent movements. If the 'RS' is stepping upward, it might indicate a reliable uptrend momentum to follow. Otherwise, stepping downward could be considered a downtrend.

Once the RS has reached its limit values, whether going (30) down or up (70), traders may expect weakening momentum in the price, indicating an oversold or overbought level.

For a deep understanding of the RSI calculation and its role, let's break down the formula:

• Average gain calculation: Results from averaging the price increment during a period, typically 14 days, but adjustable for traders' goals.
• Average loss calculation: Results from averaging the price decrement during the same period, in absolute terms.
• Relative Strength (RS): The RS comes from dividing the average gain by the average loss.
• The formula: To generate values between 0 - 100, the RSI uses the Relative Strength for the following calculation. RSI = 100 - (100 / (1+RS))

Common RSI Divergence/Convergence Strategies

Traders have been using the RSI primarily to identify divergence and convergence between the price and the indicator or against other indicators.

Using the RSI to look for divergence and convergence helps traders gauge weakening momentum and take advantage of potential reversal points in the price action.

Let's illustrate some RSI divergence and convergence scenarios that typically emerge in markets.

Bullish Divergence

For the bullish case, envision a scenario where the price makes a new low, but the RSI fails and instead does a higher low. The interpretation here will suggest the downtrend is losing momentum and a price reversal to the upside is near to start. 

Traders can proceed to the confirmation by looking for additional signals like bullish candlestick patterns or price rebounding off support levels.

Bearish Divergence

For the bearish case, picture a market where the price makes a new high, but the RSI fails and instead does a lower high. The market here will indicate the uptrend momentum is weakening, and a price reversal to the downside is close to happening.

Traders can proceed to the confirmation by looking for additional signals like bearish candlestick patterns or price rejection over resistance levels.

Bullish Convergence

For the bullish convergence, seek a moment during a trend when the price and RSI are both stepping upward. This condition will reinforce the uptrend momentum, indicating a continuation in the price path.

Traders can proceed to the confirmation by looking for a volume increase alongside the price, making the uptrend signal reliable.

Bearish Convergence

For the bearish convergence, seek a moment during a trend when the price and RSI are both stepping downward. This condition will fortify the downtrend momentum, indicating a continuation of the price decline.

Traders can proceed to the confirmation by looking for high volume during selling pressure seasons, making the downtrend signal more precise.

Advanced Techniques for RSI Divergence/Convergence

For an advanced application of divergence and convergence techniques, traders may use other tools as confirmation, like support and resistance, candlestick or chart patterns, and even combine RSI with a second indicator.

Combining RSI with a second indicator can strengthen signals, for example, using MACD or CCI. For this guide, let's discuss more interesting approaches regarding divergence and convergence signals, like using volume and discovering hidden divergences.

RSI with Volume indicator

The combination of RSI with Volume can offer various applications since volume indicates the number of orders flowing in the market, for example:

• Volume on overbought level: An increasing volume alongside an RSI over 70 suggests a substantial overbought condition, and the market might be ready for a price correction.
• Volume on oversold level: An increasing volume alongside an RSI below 30 suggests a significant oversold condition, and the market might be ready for a price rebound.
• RSI with low volume: A notable movement in the RSI at the time volume is low could indicate that current price changes lack strength and might reverse.
• RSI on breakouts with volume: When the price breaks through some support or resistance level accompanied by high volume, a signal of potential increased momentum in the direction of the breakout has emerged.

Hidden Divergence

It is an advanced concept that makes use of different timeframe views. When the price makes a new high or low on a smaller timeframe, but the RSI does not confirm the high or low on a larger timeframe, this can signal a potential reversal compared to regular divergence.

Risk Management Considerations to Avoid Typical Pitfalls

Some mistakes when using RSI may come from wrong interpretations and taking false signals. To avoid such pitfalls, it is a good practice to carry with a set of rules regarding opening trades and protecting them properly.

Setting stop-loss and taking profits is a recommended approach for smart trading, and in the same way, taking signals just under certain conditions will help protect the balance and obtain the best risk to reward ratios.

Lets use a table to illustrate an example of rules for risk management using RSI for the divergence and convergence strategy.

Conclusion and Call to Action

The RSI has been shown to be essential for implementing techniques of divergence/convergence and obtaining reliable signals. We explored how useful it can be combined with the Volume Indicator, and remarked on the importance of risk management for a successful implementation.

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