Simple RSI Divergence Strategy for Daytrading Forex & Stocks
In the world of day trading, strategies are the backbone of a trader’s success. One such strategy that has gained popularity due to its simplicity and effectiveness is the RSI Divergence Strategy. Based on a combination of three indicators, this strategy promises high win rates when executed correctly.
At the core of this strategy is the concept of divergence. Under typical circumstances, when prices move in a certain direction, the indicators tend to follow suit. However, there are times when the indicator behaves contrary to the price direction. Such discrepancies between the price movement and the indicator are termed as divergences.
For instance, consider a scenario where the price is making higher highs, but the Relative Strength Index (RSI), one of the primary indicators in this strategy, is making lower highs. This contradictory behavior is a divergence.
Types of Divergences
Divergences are broadly classified into two:
- Regular Divergence
- Hidden Divergence
For the purpose of this strategy, our focus will remain on hidden divergences. These are special because they signal a potential continuation of the current trend. Hidden divergences can further be bifurcated into:
- Bullish Hidden Divergence: Occurs when prices make higher lows, but the RSI indicates lower lows.
- Bearish Hidden Divergence: Comes into play when prices are making lower highs, but the RSI is indicating higher highs.
Identifying Hidden Divergences
Spotting these divergences in real-time trading scenarios can be challenging. A handy tip is to switch to a line chart for clearer visualization. The 200 EMA (Exponential Moving Average) plays a pivotal role in determining the type of hidden divergence to look for. If the price is above the 200 EMA, one should look for bullish hidden divergences, and if below, the focus shifts to bearish hidden divergences.
Once a divergence is spotted, it is crucial not to jump the gun. The appearance of a divergence doesn’t guarantee a trend continuation. Hence, to add another layer of confirmation to your analysis, the Stochastics indicator comes into play.
For a buy position, wait for the Stochastics to cross over upwards post identifying a bullish hidden divergence. Conversely, for a sell position, after spotting a bearish hidden divergence, wait for the Stochastics to crossover downwards.
A smart exit strategy is crucial. For buy positions, place the stop loss below the nearest swing low. The profit target should be 1.5 times the stop loss. For sell positions, the stop loss should be above the nearest swing high, with the profit target again being 1.5 times the stop loss.
The RSI Divergence Strategy is a potent tool for day traders, especially when combined with the 200 EMA and Stochastics. While no strategy guarantees absolute success, this one, with its layered approach to confirmation, offers traders an edge in the competitive world of forex and stock trading. As with any strategy, it’s crucial to practice, understand the nuances, and adapt to real-time challenges for optimal results.