How to Create a Trading Strategy Using RSI Divergence and Convergence

Getting into the crypto market can be a real challenge. Even though the world of trading is full of concepts, indicators, and strategies, focusing on one kind of strategy compatible with one indicator, like the RSI, can be a good practice to overcome confusion due to so much information available.

At Altrady, we've helped thousands of crypto traders use RSI divergence and convergence to identify high-probability trading opportunities. This guide provides a comprehensive, step-by-step approach to building a complete trading strategy around these powerful concepts.

RSI Strategy: A Full Approach to Divergence/Convergence

Using the Relative Strength Index (RSI) effectively for divergences and convergences goes beyond just putting the oscillator to work. The development of this strategy will require evaluating some criteria that guarantee a methodologic application.

RSI is a versatile tool that can help overcome multiple market conditions. Deciding which market conditions we will address is the first step to setting the indicator's parameters, establishing rules for signal confirmation, identifying entry and exit points, and proper risk management.

So, what market conditions may we face in crypto? Let's point some out:

1. Volatile markets: Typically, this type of environment is affected by news and events regarding the chosen coin asset and might offer great opportunities for traders with high-risk tolerance.
2. Trending markets: These are seasonal markets where the price of an asset keeps going in one direction, bullish or bearish, driven by a strong market sentiment. This type of environment is better suited for less risky traders.

Those two market environments are great options for applying divergence and convergence strategies using RSI.

Advanced Techniques To Consider

An effective trading strategy matches a trader's capabilities and weaknesses. Personalizing an RSI strategy also based on timeframes will boost the chances of getting the best results while staying along the implementation curve. It means avoiding changing your strategy constantly and sticking to the plan even during a losing streak.

Let's explore some advanced techniques to develop an RSI strategy based on this method:

• Setting RSI parameters: Traders can adjust the period of calculation of the indicator, which by default is 14 days, as well as the thresholds of overbought (70) and oversold (30) levels at which the RSI would signal. This way, the indicator will behave more or less sensitive to volatility based on the risk tolerance of traders.
• Confirmation Patterns: Using a second indicator like Moving Averages and Stochastic or price action concepts like support, resistance, chart, and candlestick patterns will strengthen the signals spotted by the RSI.
• Zero Line Crossovers: Bullish momentum emerges when the RSI line crosses above the midpoint zero line (50) between 0 and 100 values. Otherwise, bearish momentum occurs when the line crosses below. This concept is highly convenient to use in combination with Moving Averages.
• Double Crossovers: When the RSI line crosses the midpoint line once and then crosses back again, it strengthens the signal for trend confirmation in either direction when used with Moving Averages.

Identifying Divergence and Convergence - A Step-by-Step Guide

Divergence and convergence are simple concepts that try to take advantage of weakening and strengthening price movements, respectively. By understanding and mastering these concepts, traders will identify them in various scenarios.

In the case of divergence, when the RSI moves in the opposite direction of the price, it spots a weakening in the movement or a trend. In the case of convergence, when the RSI moves following the direction of the price, it reinforces the movement and the trend.

Let's see how to use these concepts with chart examples.

RSI Levels to Consider

Bearish divergence

The price makes a swing high while the RSI does not follow the movement, and instead, it makes a lower high near or over the 70 threshold, indicating an overbought level. It is a potential reversal point in an uptrend for the downside.

Bullish divergence

The price makes a swing low while the RSI does not follow the movement, and instead, it makes a higher low near or over the 30 threshold, indicating an oversold level. It is a potential reversal point in a trend for the upside.

Bullish convergence

The price is moving up alongside the RSI. The indicator is not overbought but is crossing the midpoint of 50, indicating strength in the upward direction.

Bearish convergence

The price is moving down alongside the RSI. The indicator is not oversold but is crossing the midpoint of 50, indicating strength in the downward direction.

Hidden divergence

Hidden divergence occurs when the RSI moves in the direction of the trend but makes an opposite move during a pullback that indicates a continuation of the existing trend rather than a reversal

• During an uptrend: The price makes a higher low, but the oscillator makes a lower low.
• During a downtrend: The price makes a lower high, but the oscillator makes a higher high. 

Bullish Hidden Divergence

Building an RSI Divergence/Convergence Trading Strategy

Building a trading strategy based on RSI divergence/convergence signals implies clustering various concepts that can serve as criteria to identify proper markets and reliable signals, establish confirmation methods, and rules for entry or exit points.

This strategy should address the following points:

• Market Context: This point refers to analyzing and identifying whether the market is bullish or bearish and what type of structure it is forming. Some trends may be driven by strong moves while others can move slowly. In every case the market tends to form ranges and breakouts. Typically, a false breakout can indicate a divergence in the RSI.
• Look for Divergence/Convergence: Identify situations where the RSI differs from price action as explained above.
• Look for Confirmation: Seek trendline breaks after spotting a divergence or candlestick patterns like the Morning Star and Evening Star.
• Entry/Exit Point: Determine the way of entering a position, for example, when a candlestick closes below (uptrend) or above (downtrend) a trendline break.

Example:

The market context in the image above shows an uptrend which we identify by drawing a trendline.

Following the Divergence signal, we look for confirmation of a trend reversal by waiting for a trendline break.

Finally, the market makes a reversal move.

Making A Trading Plan For RSI Trading Strategies

Let's illustrate with a table a simple example of a trading plan integrating a divergence/convergence strategy using RSI analysis.

RSI Limitations and Risk Considerations

The Relative Strength Index is a reliable indicator but is not exempt from limitations and misleading signals. That's why developing a concise analysis integrated with a trading plan is a recommended practice to surpass the limitations of common pitfalls.

Consider using chart patterns or a second indicator like:

1. RSI with Volume to confirm decisive price movements.
2. RSI with Stochastic Indicator to confirm overbought/oversold levels.
3. RSI with Moving Averages to reinforce trend directions.
4. Chart patterns like head and shoulders alongside a divergence signal can reinforce the end of a trend.

Avoiding Common Pitfalls

Relying solely on the information offered by RSI can lead to mistakes. Also consider:

• Backtesting Regularly.
• Paper Trading.
• The overall market context, with fundamental and technical aspects, ensures the adaptability of the trading plan.
• Smart trading tools like stop-loss and take-profit targets.

Conclusion

Divergence and convergence are powerful concepts to spot signals in the crypto market. Traders can level up their performance to overcome volatility and follow trends, setting the RSI for this strategy.

Using RSI with other indicators will boost the reliability of signals. Developing a trading plan based on a chosen timeframe will help clarify what are the best conditions to make entries. Do not forget risk management and paper trading to guarantee the effectiveness of the RSI strategy.

Altrady offers an excellent trading suite covering all the aspects discussed in this guide. Sign Up for FREE and start creating divergence/convergence strategies for crypto markets.