Have you ever wondered how much money you could make trading forex if you had the power to predict the future? If you have, you are not alone as most forex traders have had exactly the same thought at some point in their trading careers.
Think about it …
First, you mastered the fundamentals of the foreign exchange markets. Then you learned the ins and outs of the MT4/MT5 trading platform. You’ve even acquired a good grasp of technical analysis. You’re doing great, but if you are like most traders, you’re probably still asking yourself which currency pair you should buy or sell.
The fact is that traders spend years developing their forecasting abilities and learning to better predict price movements. We are all looking for that one technical indicator or trading strategy that will work every time — the elusive secret to consistent trading success.
Most traders quickly realise that although there is no magic trading solution, there are certain strategies that outperform others. One strategy, in particular, is increasingly seen as the go-to trading technique. Want to know what that strategy is and how you can use it in your trading? Keep reading!
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How an RSI indicator shows divergence
Most traders are familiar with the Relative Strength Index (RSI) indicator. It is a leading indicator commonly used to identify oversold and overbought conditions within charts. But what is RSI good for?
Imagine you are driving on a dusty road across bumpy unpredictable terrain. The road ahead is curving to the right, but all the traffic ahead of you is veering left. This divergence is a clear sign that something unusual is happening up ahead. This is not guessing, this is forecasting.
Forecasting a price divergence on a trading chart is equally effective and can be done with the naked eye. It’s obvious when a price is going one way, but the RSI indicator is going the other. When it happens, it’s usually a sure sign that something is about to happen, and that something is, more often than not, a price reversal.
When trading forex, there are two types of divergence indicators to watch out for: bullish and bearish.
Trading bullish divergence
Usually, the RSI line runs parallel with the price line. You can see a bullish divergence with the naked eye on a chart. If the price line is falling, but the RSI is on the rise, then there is bullish divergence and a price shift is being forecast. The concept is simple. The RSI is rising, and the divergence trader expects the price to follow. The longer the divergence, the slower the price reversal.
Trading bearish divergence
This is a price line on the rise, while the RSI is falling. This divergence often precedes a selling opportunity. A bearish divergence gives the divergence trader an excellent indicator long before the price shift begins. Here’s a perfect example:
A bearish divergence can be seen between the price and the RSI indicator. This is an indication that the price trend may be about to reverse.
As you can see from the two price shifts in June and September, the green price line continued to rise, even though the RSI indicator (the purple line) dropped. These are bearish divergence indicators in action. Traders who noticed these opposing directions would have likely predicted and acted upon a price shift long before it happened.
Since the RSI was on a downward trend (bearish divergence), a trader would need to place a SELL order to make a profit on this opportunity. Every trader who opened a SELL position, after using the RSI to identify a bearish divergence, would have made two very profitable trades based on the price chart above.
Divergence trading tips
Now it’s time to try using RSI divergence for yourself. Feel free to test different timeframes. The lower timeframes, such as 15 minutes, may be good to practice on since divergence will occur more often over shorter periods. Once you feel more comfortable, you can move up to the higher “swing trading” timeframes like 4 hours or even 1 day for a more relaxed experience. Consider starting with a lower level of leverage with the goal of slowly building up your equity. Exness has a free demo account too, so you can test larger investments over longer periods.
Check out the educational materials in the Exness Help Center to further your trading knowledge, and keep an eye on FX News for up-to-date market news.
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