RSI and Divergences: Powerful Signals You Must Understand

The Relative Strength Index, better known as RSI, has established itself as one of the most reliable technical indicators for identifying extreme conditions in the market. However, what truly sets experienced traders apart is their ability to recognize the divergences generated by this oscillator, early signals that often anticipate trend reversals with remarkable precision.

What is RSI Really?

RSI belongs to the family of momentum indicators and measures the relative strength between bullish and bearish closes over a specified period. Its main value lies in two fundamental characteristics:

(1) Normalizes extreme price fluctuations, eliminating noise and erratic values from analysis.

(2) Operates within a fixed band from 0 to 100, allowing quick interpretation of the relative position of price movements.

The formula behind this indicator compares the magnitude of upward versus downward movements, normalizing the result on that 0 to 100 scale. By default, it uses 14 periods, although this parameter is fully flexible according to your trading strategy.

Interpreting Critical RSI Zones

When RSI reaches values above 70, the asset is considered overbought, though this does not guarantee an immediate decline. An asset can remain in that zone for extended periods if buyers are still willing to pay higher prices. When the price pulls back from there, it could simply be a temporary correction within a broader bullish trend.

Conversely, when it falls below 30, we are in oversold territory. The price tends to recover, but again, assets with weak fundamentals can remain depressed indefinitely. Corrections from this zone do not always indicate a trend reversal.

The critical point: No oscillator can replace visual trend analysis. RSI should be considered a necessary condition, while chart validation is the sufficient condition to execute trades.

The Middle Level: The Most Important Invisible Line

The 50 level of RSI acts as a fundamental equilibrium point. When the indicator oscillates between 50 and the overbought zone (70), the asset’s price tends to increase steadily. Conversely, when it fluctuates between 50 and the oversold zone (30), the price tends to decrease.

This middle level is especially valuable for trend validation. A bullish consolidation is characterized by RSI retracements that do not fall below the 50 level. As long as this condition holds, dips represent opportunities to increase long positions, not signals of trend change.

Consider the case of Meta Platforms (NASDAQ: META) between 2020 and 2022. In March 2020, the indicator hit oversold levels and the price began an upward trend. During months, each RSI retracement stayed above 50, confirming that the bullish consolidation remained in effect. Only when the indicator crossed the 50 level multiple times in February 2022, while the price broke its trendline, was the trend reversal confirmed towards a bearish consolidation.

Buy Signals: Three Necessary Conditions

A valid buy signal requires the simultaneous fulfillment of three criteria:

1. RSI reaches oversold zone (below 30)
2. The indicator returns to the normal fluctuation band
3. The price breaks the previous downtrend line

Taiwan Semiconductor Manufacturing (NYSE: TSM) provided a textbook example between September and October 2022. RSI remained oversold for several weeks, then recovered, and when the price finally broke the previous downtrend line from January, a high-probability long entry was set up.

The critical aspect here is patience. RSI can undergo multiple inflection points within extreme zones before generating the final signal. Jumping the gun without confirmation of the breakout often results in premature trades.

Sell Signals: The Mirror of Buying

Conditions are analogous but inverted:

1. RSI reaches overbought zone (above 70)
2. The indicator retraces to the fluctuation band
3. The price breaks the previous uptrend line

Applied Materials Inc. (NASDAQ: AMAT) between November 2020 and January 2022 illustrates this pattern. The indicator stayed overbought for months with a strong upward trend. When it retraced and settled in the middle band, while the price developed a lateral range, it was only a matter of time before the bearish breakout occurred, confirming a short entry.

RSI Divergences: The Most Powerful Tool

This is where technical analysis transcends the ordinary. Divergences between price and RSI are extraordinarily effective early signals.

Bullish Divergence: When Price Falls but the Indicator Rises

This divergence occurs when, during a downtrend, the price makes progressively lower lows, but simultaneously RSI forms higher lows. This indicates that selling pressure is weakening while demand gains ground. It’s essentially a warning of an impending bullish reversal.

Broadcom (NASDAQ: AVGO) in the semiconductor sector demonstrated this clearly. While the price fell to deeper lows, RSI in oversold territory began to raise its lows. The predicted bullish divergence materialized into a vigorous upward trend that lasted for months.

Bearish Divergence: When Price Rises but the Indicator Falls

The opposite scenario occurs when, during an uptrend, the price makes higher highs, but RSI in overbought territory forms lower highs. The market internally loses strength despite prices continuing to rise.

Walt Disney (NYSE: DIS) provided a masterful case. The price made progressive highs in 2021, suggesting trend continuation. Simultaneously, RSI showed decreasing highs in overbought territory, revealing a loss of momentum. The bearish divergence was resolved with a sustained decline that persists months later.

Divergences are the secret that distinguishes professional technical analysts. They are not false signals like other indicators; they are genuine warnings of the coming change.

Combining RSI with MACD: Confirmed Robustness

Although RSI is powerful, it can generate false signals, especially on very short timeframes. A common strategy is to complement it with MACD, the Moving Average Convergence Divergence indicator.

MACD uses three components: the MACD line, the SIGNAL line, and a Histogram that fluctuates around zero. Conditions for more robust signals would be:

1. RSI reaches overbought or oversold levels (necessary condition)
2. RSI retraces to the fluctuation band
3. MACD line crosses the histogram’s midline in the opposite direction of the trend (sufficient condition, entry signal)
4. MACD line crosses the SIGNAL line in the opposite direction (exit signal)

Block Inc. (NYSE: SQ) between 2021 and 2022 exemplified this combination. Starting from overbought RSI, the indicator declined while MACD crossed downward the zero level of the Histogram. This dual confirmation allowed opening shorts with confidence. The position was closed when MACD made a bullish crossover over its SIGNAL line four months later, protecting gains in a downward move that persisted.

Tesla Cases: Long-lasting Trends and Regime Changes

Tesla (NASDAQ: TSLA) between 2019 and 2022 offers the most comprehensive lesson on how to interpret RSI and divergences in different scenarios.

In May 2019, RSI was in oversold territory. When it exited this zone, the price started forming higher lows, establishing a clear bullish trend. RSI reached overbought in February 2020 (COVID-19 pandemic), but then retraced without falling below the middle zone. This RSI correction indicated a temporary consolidation, ideal for increasing long positions.

Throughout 2020, RSI made three consecutive overbought highs between June and December. Each correction stayed above the middle level, reaffirming the dominant bullish trend. Dips were opportunities, not trend reversals.

Between February and May 2021, RSI again fell but did not significantly breach the 50 level. Another bullish consolidation. In October 2021, RSI reached overbought again, but here a critical difference emerged: RSI no longer reached new overbought highs, while the price began forming lower highs. A bearish divergence was developing.

In December 2021, the definitive breakdown arrived. Price broke the previous uptrend, and RSI fell into oversold territory. From that point, while RSI fluctuated between oversold and the middle level (never returning to overbought), the price continued downward, validating the new bearish consolidation.

The Synergy Between Oscillators and Trends

Operational success depends on understanding that RSI and its divergences are leading oscillators. They provide early signals but are not sufficient alone. Visual validation on the price chart — broken trendlines, support/resistance levels losing validity — is what turns a possibility into a probable trade.

When the RSI indicator shows divergences, it captures the market’s hidden dynamics. When the price forms new highs but RSI does not, the market is exhausted. When the price forms new lows but RSI does not, selling pressure is weakening. These disconnects are pure gold for the prepared technical analyst.

The combination of RSI, divergences, and trend analysis on the chart, occasionally complemented with MACD, provides a system of signals with considerable robustness. It is not infallible, but it significantly increases the odds of success in stock markets.