RSI divergence: when a new low comes with less selling

RSI divergence is a disagreement between price and momentum. Price falls to a new low, but the push down is weaker than the one before. Traders use it to spot a selloff that is running out of steam, and to buy the turn with a stop just under the new low.

How it works

RSI (relative strength index) is a gauge from 0 to 100 that compares the size of recent up moves to recent down moves over the last 14 candles. Strong, steady selling pushes it low. When selling slows, it climbs, even if price is still drifting down.

To compare lows you need a clear definition of one. A swing low is a candle whose low is below the lows of the 3 candles before it and the 3 candles after it. That means you only know a swing low exists 3 candles later.

Bullish divergence is when the last two swing lows disagree. Price made a lower low: the second low is below the first. But RSI at the second low is higher than RSI at the first. Price went further, yet the selling that got it there was less forceful. Sometimes that is the first sign that sellers are tiring.

On its own, divergence is only a warning. Price can keep making lower lows with RSI diverging all the way down. So this version waits for confirmation: a candle that closes above the previous candle's high. That shows buyers stepped in hard enough to take out a recent high, not just that selling slowed.

The rules, precisely

Here is one precise, testable version of this strategy. Traders vary these numbers. It is written for a long. The short is the mirror image: a higher high in price with a lower high in RSI.

1. Lower low in price: of the last two swing lows, the second is lower than the first.
2. Higher low in RSI: RSI at the second swing low is higher than RSI at the first.
3. Stretched: RSI was below 40 at the second low.
4. Recent: the second low is within the last 10 candles.
5. Confirmation: this candle closed above the previous candle's high.
6. Entry: at the close of the confirming candle.
7. Stop: below the second low, minus 0.2 ATR (average true range, the typical size of a recent candle).
8. Target 1: the highest high between the two lows.

What to check

1. What is the bigger trend doing? Look one timeframe up. If it is trending down (close below its 20 EMA, the 20 below the 50), divergence is fighting the current and fails more often. The setup has more room when the bigger chart is flat or rising.
2. Are the swing lows meaningful? Two tiny dips a few candles apart are not the same as two clear lows that other traders can see. Divergence between real, visible lows carries more weight than divergence found by zooming in.
3. Where is the second low relative to support? A lower low that sweeps just under a previous low or a known level and then turns is a cleaner story. A lower low in the middle of nowhere is weaker.
4. How big is the confirming candle? A huge green candle can put the entry far from the stop. Check that the stop is inside 0.25 to 4 ATR and that the high between the lows is still at least 1.5 R away.
5. Is there news? Momentum gauges cannot see news. If the coin fell on something that changes its value, slower selling may only mean the market is waiting for the next headline.
6. What does volume show? Lighter volume on the second low supports the idea of tiring sellers. Heavier volume on the second low says sellers were active, and the RSI reading may be misleading.
7. Are you on a short timeframe with a tight stop? On 15-minute candles the distance to the second low can be small. Check that round-trip fees cost no more than 0.3 R, or the edge goes to the exchange.

Stops, targets and the time limit work the same way for every setup in this series. See managing a setup: stops, targets and the time limit.