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overbought in a bull market. The indicator can remain oversold or overbought for quite a while. |
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According to Wilder, the greatest value of the RSI is in pointing out a divergence between the RSI and price. As Figure 16-2 shows, a bullish divergence (or as he calls it a bottom failure swing) occurs when the price makes a low while the RSI (when under 30) fails to make a new low. This can be seen at point c, where the RSI value is higher than at point a, while the price is lower. When the RSI proceeds to exceed the previous RSI peak (at point b), a short-term buy signal is generated according to Wilder. The opposite applies to a bearish divergence, and is considered a short-term selling opportunity. In Figure 16-3, we can see how 70 acts as resistance and 30 acts as support. The typical trader uses the RSI to identify a bearish divergence when the RSI is over 70, and a bullish divergence when the RSI is under 30. |
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That pretty much sums up public knowledge about the RSI. However, what the average trader comprehends is a small part of the overall picture, |
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Figure 16-2
Bullish Divergence |
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Key:
a Price is at 100, RSI is at 22
b Price is at 102, RSI is at 32
c Price is at 98, RSI is at 27 |
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