Market Reversal from RSI Divergence: A Must-Learn Technical Analysis Course

Beginner investors in stocks often come into contact with various indicators, among which RSI (Relative Strength Index) is one of the most practical and easy-to-learn tools. However, understanding the basics alone is not enough; top investors study RSI divergence as a hidden market signal. Today, we will delve into how to use RSI effectively, especially how to identify divergence phenomena and how to respond when the indicator becomes dull.

Core Logic of the Relative Strength Index (RSI)

RSI (Relative Strength Indicator) is a technical indicator that measures price momentum. It calculates the ratio of upward to downward price movements over a certain period to assess the strength of buyers and sellers in the market. Simply put, RSI quantifies market heat with numbers.

Why do investors favor RSI? Mainly because its logic is intuitive and calculations are transparent. Unlike indicators like MACD that require complex computations, RSI can be understood with basic arithmetic, making it very suitable for beginners in technical analysis.

On charting tools, RSI is often displayed alongside indicators like KD and MACD to help investors quickly judge entry and exit points.

Clear Explanation of RSI Calculation Method

The calculation process of RSI can be divided into three steps:

Step 1: Select a period and calculate average gains and losses

A standard period of 14 days is commonly used. Sum all upward price changes over these 14 days and divide by 14 to get the average upward movement; do the same for downward movements to get the average downward movement.

Step 2: Calculate the Relative Strength (RS)

Divide the “average upward movement” by the “average downward movement” to obtain the RS value.

Step 3: Convert to RSI value

Using the formula RSI = 100 - (100 ÷ (1 + RS)), you get a value between 0 and 100.

This value range is not arbitrary; it forms three key zones based on market conventions:

• RSI > 70 (Overbought Zone): Market is overly optimistic, and prices may face a pullback
• RSI < 30 (Oversold Zone): Market is overly pessimistic, and prices may rebound
• Between 30 and 70: Market is in a relatively balanced state

It’s important to note that while RSI is a useful tool, it is not foolproof. During strong upward or downward trends, these standard thresholds may fail.

RSI Divergence: Hidden Signal of Reversal

RSI divergence is one of the most noteworthy phenomena in technical analysis. Simply put: When the price trend and RSI indicator move in opposite directions, it often signals an impending reversal.

RSI divergence mainly occurs in two forms:

Top Divergence (Bearish Signal)

When prices keep making new highs but RSI gradually declines, it forms a top divergence. This indicates that upward momentum is weakening; even if prices are still rising, the trend is nearing exhaustion.

For example, Bitcoin once rose from $70,000 to $100,000, creating a new high, but during the same period, RSI dropped from 82 to 58. This classic divergence—price hitting a new high while RSI falls—suggests the bullish trend may be ending. Investors should consider reducing positions or preparing to exit to avoid potential corrections.

Bottom Divergence (Bullish Signal)

Conversely, if prices hit new lows but RSI does not follow suit and instead shows signs of stabilization or rising, it indicates weakening downward momentum and a possible rebound. Investors can consider gradually building positions in anticipation of a bottom.

Understanding the essence of divergence: RSI divergence reflects an imbalance in market sentiment. When price and indicator diverge, market participants are under pressure, and this tension will eventually be released, causing the price to move in the opposite direction to restore balance.

However, it’s crucial to remember that RSI divergence, while powerful, is not an absolute predictor. Investors should confirm signals with other indicators (like trendlines, volume, etc.). Especially in strong trends, divergence phenomena can persist for a long time before a genuine reversal occurs.

RSI Dulling Phenomenon and How to Respond

RSI has a critical flaw called dulling. This occurs during extreme market conditions (strong rallies or declines), where RSI remains in overbought or oversold zones for extended periods, losing sensitivity to price changes.

For example, during a bull market, RSI might stay above 75 for a long time, seeming to signal overbought conditions and a sell, but the market continues to rise. At this point, RSI’s warning becomes ineffective. This is the dulling effect.

To address RSI dulling, investors can adopt the following strategies:

1. Combine trend analysis

Don’t be misled by superficial overbought or oversold signals. Observe whether the overall trend has truly changed. If the trend remains upward, then high RSI levels are not necessarily a sell signal.

2. Use multiple technical indicators

Relying solely on RSI can lead to errors. Incorporate moving averages, MACD, volume, and other signals for multi-dimensional confirmation.

3. Adjust RSI parameters

If dulling occurs frequently, consider changing the period. For example, from 14 days to 10 or 20 days. Shorter periods increase sensitivity; longer periods smooth out short-term noise.

4. Implement strict risk management

Dulling periods are high-risk times. Set clear stop-loss points to avoid blindly chasing rallies or selling in panic.

Practical Application: Multi-angle Use of RSI

RSI and the 50-Midline Comparison

The 50 line is a dividing line for RSI:

• RSI > 50: Bullish strength dominates, market tends to be optimistic
• RSI < 50: Bearish strength dominates, market tends to be pessimistic

A detail often overlooked: if RSI repeatedly crosses the 50 line during divergence formation, it indicates market oscillation without a clear trend. In such cases, divergence signals lose their effectiveness.

Extreme Sentiment Zones as Warning Signs

RSI overbought and oversold zones reflect extreme market sentiment:

• RSI > 80: Deep overbought, higher risk of correction
• RSI < 20: Deep oversold, higher chance of rebound

In strong trending markets, these signals may fail; thus, they should be combined with trendlines and other indicators for comprehensive judgment.

Multi-period RSI to Improve Analytical Accuracy

To avoid limitations of a single period, traders can set multiple RSI lines, such as 6-day, 12-day, and 24-day:

• W-shape: When all RSIs are below 50 forming a W, bearish momentum weakens, possibly leading to a rebound
• M-shape: When all RSIs are above 50 forming an M, bullish momentum is insufficient, possibly reversing downward

Golden Cross and Death Cross

When RSIs of different periods cross each other, it produces strong signals:

• Golden Cross: Short-term RSI crosses above long-term RSI, indicating strengthening upward momentum, possibly a buy signal
• Death Cross: Short-term RSI crosses below long-term RSI, indicating strengthening downward momentum, possibly a sell signal

Adjusting RSI Parameters According to Trading Style

The standard RSI parameter of 14 is not fixed. Different traders should adjust based on their trading cycle:

Short-term traders: Use 3-5 days to make RSI more sensitive, capturing short-term opportunities promptly.

Mid-term traders: Use 6-12 days, balancing responsiveness and filtering out short-term noise.

Long-term investors: Use 14-30 days, making RSI smoother and more stable, focusing on major trends rather than short-term fluctuations.

When adjusting parameters, keep in mind: shorter periods lead to more volatile RSI with more false signals; longer periods produce smoother RSI but with delayed reactions.

Summary

RSI is popular because of its simplicity and power. However, top traders not only interpret RSI itself but also recognize hidden signals like divergence and are prepared to handle dulling effects. Mastering multi-period RSI analysis, golden and death crosses, combined with trend analysis and other indicators, enables more rational decision-making in complex markets.

Whether you are a novice or experienced in technical analysis, regularly review your understanding of RSI, and adjust parameters and strategies based on actual trading experience.