\u2022 To identify overbought and oversold conditions
\n\u2022 To spot classic and hidden divergences (bullish and bearish)
\n\u2022 To serve as a leading indicator to generate buy and sell signals<\/p>\n
Overbought\/Oversold Conditions<\/h2>\n
The chart below shows you the overbought and oversold levels of the RSI (14-period). A stock can proceed to go lower than the oversold line (30) or higher than the overbought line (70) depending on the speed of the movement of price.<\/p>\n
The RSI readings below show that a stock can proceed to go over or under overbought and oversold regions and still go into the same direction.<\/p>\n Overbought conditions can be used as a signal to trim down your shares when you are in gain to cash-in some of your profits. It can also be used as a possible signal that a pullback is about to impend. So if you\u2019re the type of trader who\u2019s good at pullback setups, then this may be of use to you.<\/p>\n Oversold conditions, meanwhile, can indicate a possible exhaustion in selling. This is where traders who trade bounce plays sometimes look at when they identify their trading setups.<\/p>\n Note that it would be unwise to passively buy stocks just because they\u2019re oversold or to automatically sell all your position when it\u2019s overbought. Always be systematic when buying or selling so that you won\u2019t let greed, fear, or hope, take over your trading.<\/p>\n A divergence indicates a possible change or reversal in the underlying trend. It happens when price is not \u201cin-sync\u201d with momentum. Divergence is not limited only to the RSI as this could also be seen in other indicators such as Moving Average Convergence\/Divergence (MACD) and the Commodity Channel Index (CCI), to name a few. When divergence is found in a higher timeframe (like weekly, monthly), it\u2019ll give a much stronger signal.<\/p>\n There are two types of divergences:<\/strong> the bullish and the bearish. When looking for the latter, search for lows. For the former, look at the highs.<\/p>\n A bullish divergence (positive divergence) happens when price makes a lower low whereas the momentum indicator makes a higher low. This means that there is a high probability that selling-pressure is weakening and buying (demand) could soon take over.<\/p>\n After Metro Pacific Investments Corporation (MPI) generated a bullish divergence using the RSI (14) in the 1-hour timeframe, it went on to break the previous high around 4.65\/sh and then created a higher high around 4.75\/sh. It also created a higher low in the few candlesticks. The bullish divergence signified the change in trend, from a downtrend to an uptrend, for MPI.<\/p>\n Below are a few more examples:<\/strong><\/p>\n A bearish divergence (sometimes called as negative divergence) happens when price makes a higher high but the momentum indicator makes a lower high which means that the buying momentum was not strong enough to warrant a new high. It could be an indication that buying is waning down, and profit-taking is imminent.<\/p>\n Divergence can be as subtle as the one you can see below. The angle of the slope line may not be as angled as the previous charts you saw. But if you observe closely, the exact RSI reading of the high on the left (RSI = 92.3651) from the high on the right (RSI = 91.4676), it would show that it indeed made a lower high. And as you can see on the right side of the chart, the stock went on to start a downtrend (series of lower lows and lower highs).<\/p>\n Hidden divergences are different from classic divergences. The latter indicates that there could be a reversal (uptrend to downtrend or downtrend to uptrend) to the underlying trend, whereas the former could sign as a continuation in the current trend. The theory of \u201cbuying the dips, selling the rallies\u201d may be utilized here.<\/p>\n Hidden Bullish Divergence often found during retracements in an uptrend. As you can see in the chart below, San Miguel Corporation (SMC) is in an uptrend when the hidden divergence is spotted during the pullback in price action. The concept of \u201cbuying the dips\u201d can be used here.<\/p>\n![\"\"](\"https:\/\/dailymedia.investagrams.com\/investadaily\/2019\/03\/RSI.jpg\")
<\/a><\/p>\n<\/a><\/p>\n<\/a><\/p>\nDivergences<\/h2>\n
Bullish Divergence<\/em><\/h3>\n
<\/a><\/p>\n<\/a><\/p>\n<\/a><\/p>\nBearish Divergence<\/em><\/h3>\n
<\/a><\/p>\n<\/a><\/p>\nHidden Divergences<\/h2>\n
Hidden Bullish Divergence<\/em><\/h3>\n