RSI / MACD divergences

What is a Trading Divergence?

A divergence occurs when price action moves in one direction, while a technical indicator moves in the opposite direction. This can signal a weakening of the current trend and alert traders to a possible reversal or slowdown in momentum.

There are two main types of divergence:

1. Bullish Divergence : Occurs when the price forms lower lows, but the indicator forms higher highs. This may indicate a potential bullish reversal.

2. Divergence Baissière : Occurs when the price forms higher highs, but the indicator forms lower lows. This may signal a potential bearish reversal.

RSI Divergence Detection

Reminder: What is the RSI?

The RSI is an oscillator that measures the relative strength of an asset's gains and losses over a given period (usually 14 periods). It varies between 0 and 100 and is often used to identify overbought (>70) and oversold (<30) conditions.

How to Detect Bullish Divergences with the RSI

A bullish divergence on the RSI occurs when the price hits lower lows, but the RSI forms higher lows. This suggests that selling pressure is weakening, even if the price continues to fall.

Example:

• On a EUR/USD chart, the price forms successive lows at 1.0800 and 1.0700.
• The RSI, however, is forming lows at 25 and 30, showing higher lows despite falling prices.
• This divergence indicates an increased probability of a bullish reversal.

How to Detect Bearish Divergences with the RSI

A bearish divergence occurs when the price reaches higher highs, but the RSI forms lower highs. This indicates a weakening of buying pressure, which may herald a downward turn.

Example:

• On a BTC/USD chart, the price rises from 25,000 $ to 26,500 $, forming higher peaks.
• The RSI, however, falls from 75 to 70, forming lower peaks.
• This divergence indicates a loss of bullish momentum, signalling a potential bearish reversal.

MACD Divergence Detection

Reminder: What is the MACD?

The MACD is an indicator based on the difference between two exponential moving averages (generally 12 and 26 periods). It is made up of three elements:

• MACD line.
• The signal line.
• The histogram, which represents the difference between the MACD line and the signal line.

The MACD is used to identify trends, crossovers and divergences.

How to detect bullish divergences with the MACD

A bullish divergence on the MACD occurs when the price reaches lower lows, but the MACD (or its histogram) forms higher lows. This suggests that the downtrend is weakening.

Example:

• On a gold chart (XAU/USD), the price forms successive lows at 1,900 $ and 1,880 $.
• The MACD histogram, however, shows successive higher lows.
• This divergence indicates a weakening of selling pressure and a potential upward turnaround.

How to Detect Bearish Divergences with the MACD

A bearish divergence occurs when the price forms higher peaks, but the MACD (or its histogram) forms lower peaks. This indicates a loss of bullish momentum.

Example:

• On a USD/JPY chart, the price rises from 140 to 142, forming higher peaks.
• The MACD, however, forms lower peaks over the same period.
• This divergence signals a weakening of the upward momentum, with an increased probability of a downward reversal.

How to Use Divergences in a Trading Strategy

Divergences, whether on the RSI or MACD, should be used in combination with other technical analysis tools to confirm signals. Here are some practical tips:

1. Confirmation with Market Context: Make sure the divergence is aligned with the general market context. For example, if the market is in a major downtrend, a bullish divergence may indicate a simple rebound rather than a complete reversal.

2. Combination with Support and Resistance Levels : Look for divergences near key support or resistance levels to maximize their reliability.

3. Using Stop-Loss and Take-Profit : Always place a stop-loss below the last low for a bullish divergence, or above the last high for a bearish divergence. The take-profit can be placed on an identified support or resistance level.

Complete practical example

Scenario: Bullish divergence on the RSI

• Assets: EUR/USD.
• Context: The price forms successive lower lows at 1.1000 and 1.0950.
• RSI: Shape of higher troughs at 28 and 32.
• Action plan :
  • Entrance : Buy at 1.0960 after confirmation of a bullish candle.
  • Stop-Loss : 1.0940 (20 pips below the entry point).
  • Take-Profit : 1.1020 (60 pips higher, for an R/R ratio of 1:3).

Result:

The price reaches take-profit after the uptrend resumes, validating the divergence-based analysis.

Conclusion

Divergences on the RSI and MACD are powerful tools for identifying potential reversals and trading opportunities. However, they must be used with caution and in combination with other technical analyses to maximize their effectiveness. By mastering these concepts and integrating them into your strategy, you can significantly improve your trading results.

We hope this article has helped you better understand divergences and how to use them effectively. If you have any questions or would like to share your experiences, join us on social networks with the hashtag #xenesy and identify @xenesy_project. Happy trading!