RSI: The Right Way to Use It & Understanding Divergences
What is RSI & Its Purpose?
The Relative Strength Index (RSI) is a leading momentum indicator that measures the speed and strength of price movements. Unlike lagging indicators, RSI provides early signals of potential trend reversals or continuations, helping traders enter trades at optimal levels while managing risk efficiently.
The standard period used by the vast majority is RSI 14, meaning RSI calculates the average gain of the last 14 candles and compares it with the average loss of the last 14 candles. The result is then plotted on the RSI indicator, ranging from 0 to 100.
How RSI Values Are Calculated & Why It Matters
If the average gain and average loss in the last 14 candles are equal, RSI will print 50.
If a red candle disappears from the last 14 candles, and a green candle replaces it, RSI will increase. This is because the calculation now accounts for less loss and more gain, pushing RSI above 50.
If a large red candle disappears and is replaced by a relatively small green candle, the RSI calculation is still skewed upward—this is crucial because it can mislead traders into thinking momentum is shifting strongly when, in reality, the move is weaker.
This dynamic behavior is the foundation of RSI divergences, which signal early shifts in market direction. Unlike lagging indicators, RSI provides a real-time edge for traders to position themselves early when risk is minimized, and reward potential is maximized.
Common Misconception: Overbought & Oversold are NOT Buy/Sell Signals
A major mistake traders make is assuming that RSI above 70 means “sell” and RSI below 30 means “buy.”
❌ Why This is Wrong:
In a strong uptrend, RSI can stay above 70 for an extended period while price continues to rise. Selling just because RSI is “overbought” can make traders exit too early.
In a strong downtrend, RSI can stay below 30 for a long time while price keeps falling. Buying just because RSI is “oversold” can result in catching a falling knife.
✅ The Right Way to Use Overbought & Oversold:
Instead of using 30 and 70 as strict reversal points, use RSI in confluence with trend structure, support/resistance, and price action as shared in lesson 8.
Example: If RSI is overbought but price is in an uptrend with no signs of weakening, it’s a sign of strong momentum, not necessarily a reversal. Similarly If RSI is oversold but price is in a Downtrend with no signs of buyers, it’s a sign of strong momentum to the downside, not necessarily a reversal.
RSI Divergences: Leading Signals for Market Reversals
Divergence occurs when price action and RSI movement do not agree, signaling a potential trend shift before it happens.
📌 1. Bullish Divergence (Reversal Signal – Potential Uptrend)
Occurs when price makes a lower low (LL), but RSI makes a higher low (HL).
This indicates that downtrend momentum is weakening, and a reversal may occur.
Often found at the bottom of a downtrend, signaling an early buying opportunity from a key level of support/demand zone.
Example:
Price: Lower Low (LL)
RSI: Higher Low (HL)
Potential Outcome: Price reversal upward.
📌 2. Bearish Divergence (Reversal Signal – Potential Downtrend)
Occurs when price makes a higher high (HH), but RSI makes a lower high (LH).
This signals that uptrend momentum is weakening, and a downtrend may follow.
Found at the top of an uptrend, signaling a potential sell opportunity.
Example:
Price: Higher High (HH)
RSI: Lower High (LH)
Potential Outcome: Price reversal downward.
Hidden Divergences: Trend Continuation Signals
Unlike regular divergences, hidden divergences suggest that the current trend will continue rather than reverse.
📌 3. Hidden Bullish Divergence (Uptrend Continuation)
Occurs when price makes a higher low (HL), but RSI makes a lower low (LL).
This shows that the uptrend is still strong, and price may continue rising.
Often found during pullbacks in a strong uptrend.
Example:
Price: Higher Low (HL)
RSI: Lower Low (LL)
Potential Outcome: Price resumes upward.
📌 4. Hidden Bearish Divergence (Downtrend Continuation)
Occurs when price makes a lower high (LH), but RSI makes a higher high (HH).
This suggests that the downtrend remains strong, and price may continue falling.
Example:
Price: Lower High (LH)
RSI: Higher High (HH)
Potential Outcome: Price continues downward.
Key Takeaways
✅ RSI is not just about 30 and 70—it’s a leading indicator that helps detect early trend shifts.
✅ RSI divergence reveals momentum loss, signaling potential reversals before price confirms.
✅ Hidden divergence helps identify trend strength and continuation trades.
✅ RSI is most effective when combined with price action, trendlines, and support/resistance.
⚠️ Important Warning:
You cannot simply enter a trade based on a potential divergence alone. There is a specific process to confirm the price shift after divergence appears.
Some of these confirmation methods are partially covered in Lesson 8, and I’ll leave you with a small clue:
💡 Big traders place entries where most traders place their stops.
This is a common phrase in the stock market, but very few actually explain how to spot these setups in real-time. If you pay close attention to Lessons 8, 9, and 10, you’ll start seeing exactly where to enter and how to confirm a trade properly.
Stay tuned—big insights are coming! 🚀
How We Use RSI at ITL
At Independent Traders Lab (ITL), we don’t just use RSI in isolation. We combine it with supply and demand zones, trendlines, and use multi-timeframe analysis to develop high-probability trade setups. This unique combination is part of our signature trading method, which we teach in our mentorship program.
In the next lessons, I will share practical examples that you can start implementing on your own to enhance your edge and refine your current strategy. If you see progress and want to take your RSI understanding to the next level, feel free to join us for more in-depth insights.