RSI and Divergence Trading: The Complete Guide to Technical Analysis in Markets

The Relative Strength Index, known as RSI or Relative Strength Index, represents one of the most effective oscillators for detecting extreme conditions in price behavior. When combined with divergence trading strategies, we obtain signals of potential trend transformations. However, it is essential to understand that the RSI works best as a complement within a comprehensive analysis system, never as a sole decision-making tool.

Understanding the RSI: Fundamental Concepts

What Does RSI Measure?

The RSI belongs to the category of momentum indicators or oscillators. Its main function is to quantify the relationship between bullish and bearish closes over a specified period. This calculation normalizes buying versus selling pressure on a fixed scale from 0 to 100.

The Relative Strength Index offers two significant advantages:

First advantage: smooths out abrupt price fluctuations, eliminating excessive noise from analysis. Second advantage: generates a constant oscillation band that facilitates visual interpretation of the price’s relative position within predefined extremes.

The RSI Formula

To calculate RSI over ‘n’ periods, use:

RSIn = 100 - [100 / ((1 + RSn))]

Where RSn represents:

RSn = Average of Upward Closes (n periods) / Average of Downward Closes (n periods)

This quotient is normalized within the 0-100 scale. The standard setting uses 14 periods, though it can be adapted according to your trading strategy.

Practical Interpretation of RSI

Critical Zones: Overbought and Oversold

When RSI ≥ 70 (Overbought Zone)

An asset at this level suggests intensified buying pressure. Theoretically, there is a probability of a bearish correction. However, this condition can persist indefinitely if investors maintain bullish appetite. Exiting this zone may represent either a temporary correction within an uptrend or the start of a structural change.

When RSI ≤ 30 (Oversold Zone)

An asset here indicates aggressive selling. Although the probability of a bullish rebound increases, staying in this zone depends on fundamentals: weak assets remain depressed longer. Similar to the previous case, exiting oversold conditions can be a correction within a dominant downtrend.

The Invisible Middle Level

Between 30 and 70, there is a critical mid-point: level 50. This level acts as a trend confirmer:

• RSI between 50 and 70: The price tends to appreciate
• RSI between 50 and 30: The price tends to depreciate

When RSI corrections do not penetrate the 50 level, they confirm consolidation of the current trend, not reversal.

Case Analysis: Tesla and Meta Platforms

Lesson from Tesla: Recognizing Direction Changes

Consider Tesla (NASDAQ: TSLA) movement between 2019 and 2022:

In May 2019, RSI reached oversold levels. After returning to the fluctuation band, the price made higher lows, confirming an uptrend. Between June and December 2020, the indicator visited the overbought zone three times but never moved away from the mid-level during corrections, confirming bullish strength.

The turning point came in October 2021. RSI reached overbought, but with decreasing highs. Simultaneously, the price developed lower highs. This divergence correctly anticipated the trend break that materialized in December. Subsequently, the indicator fluctuated between oversold and the mid-level, confirming a bearish dominance.

Trend Validation: The Meta Case

Meta Platforms (NASDAQ: META) illustrates the importance of level 50:

Since March 2020, when RSI hit oversold, the price developed an uptrend while RSI oscillated between 50 and the overbought zone. This pattern of “bullish consolidation” remained strong between June and August 2021, with multiple overbought points.

The change arrived in February 2022: breaking the previous uptrend line with RSI heading toward oversold. As long as the indicator remains between oversold and level 50, a “bearish consolidation” is developing, confirming a regime transition.

Trading Signals with RSI

Robust Buy Signal

A long entry requires the coincidence of three elements:

1. RSI reaches oversold (below 30)
2. The indicator moves back toward the central band
3. The price breaks a previous downtrend line

Taiwan Semiconductor Manufacturing (NYSE: TSM) exemplifies this: between September and October 2022, RSI remained in oversold territory. After recovering, the price broke the downtrend extending from January 2022, creating a buying opportunity.

Robust Sell Signal

A short entry requires:

1. RSI reaches overbought (above 70)
2. The indicator retreats toward the central band
3. The price breaks a previous uptrend line

Applied Materials Inc. (NASDAQ: AMAT) demonstrated this pattern: from November 2020 to April 2021, sustained overbought conditions. Then the indicator contracted while the price formed a lateral range. In January 2022, breaking the previous uptrend allowed a short entry with confirmation.

Divergence Trading: The Most Powerful Tool

Bullish Divergence

Occurs during downtrends when the price makes lower lows, but RSI produces higher lows. This disconnect anticipates a probable bullish recovery.

Broadcom (NASDAQ: AVGO) showed this pattern: within a downtrend, the price kept falling, but RSI already reflected increasing buying pressure through higher lows. Effectively, two months later, an uptrend developed.

Bearish Divergence

Arises during uptrends when the price reaches higher highs, but RSI generates lower highs. It signals loss of strength and a probable bearish reversal.

Walt Disney (NYSE: DIS) exemplifies this perfectly: the price made progressive highs, but RSI reflected decreasing highs. The oscillator captured momentum exhaustion, correctly anticipating a bearish move that persists over a year later.

Strengthening Signals: RSI and MACD

RSI occasionally produces false signals, especially on very short timeframes. Combining it with MACD (Moving Average Convergence Divergence) creates a more robust system.

Conditions for combined operation:

1. RSI reaches overbought/oversold (necessary condition)
2. RSI returns to the fluctuation band
3. MACD crosses the histogram’s midline in the opposite direction of the trend (sufficient condition for entry)
4. MACD crosses the SIGNAL line in the opposite direction (exit signal)

Analyzing Block Inc. (NYSE: SQ): starting from overbought, RSI returns and gradually declines. When MACD crosses below the histogram’s midline, it confirms a downtrend formation. A short position is opened. The exit occurs four months later when MACD crosses above the SIGNAL line.

Conclusion: Comprehensive Application of RSI

The Relative Strength Index and its divergence trading strategies are powerful tools to increase success probabilities. Their strength lies in the ability to anticipate directional changes when properly integrated with chart trend analysis and complemented with additional oscillators. Successful trading requires systematic discipline, never reliance on indicators in isolation.