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Divergence between Price and RSI

Divergence between Price and RSI

One of the best tools to get an early warning, that a possible top or bottom is close by comes from divergence between price and the RSI indicator.

Here we have taken a long-term chart of GBP ag. JPY on a weekly basis and added the RSI (14 periods), which is the standard, to look for possible divergence between price and the RSI indicator.

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The first clear divergence is seen in the time-periode from Janaury 2007 to July 2007, where the price for GBP ag. JPY rallies from 241.50 i January to a new high of 251.11 i July. However, in the same time-frame the RSI indicator falls from a peak at 73.93 in January to a lower peak at 70.99 in July. This decline in the RSI was a clear warning, that a possible top was developing and more importantly, that stops on long positions in GBP ag. JPY should be tighten.

Moving forward to the periode between late October 2008 and mid-January 2009 we see a new divergence between the price og GBP ag. JPY and the RSI indicator. After a strong downtrend where GBP ag. JPY declines from 251.11 to a low of 118.82 the final part of the price-decline in GBP ag. JPY from October 2008 till January 2009 the RSI indicator no longer confirms the decline as the RSI has a higher low at January price low again showing divergence between price and the RSI indicator and again warning of a possible bottom soon and finally giving a signal to the trader, that stops should be tighten as a possible change in trend could be close at hand.

The conclusion is, that divergence between price and the RSI indicator is one of the best early warning-signals of a possible top or bottom emerging. It's not a timing tool to take a position against the prevailing trend, but a warning-tool that the prevailing trend is close to terminating.

*The market analysis posted here is meant to increase your awareness, but not to give instructions to make a trade
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