You heard a lot about RSI divergence and how it is a powerful way to detect reversals. Now this is true. RSI is very powerful in detecting reversals and trend continuations alike.
Now if you have been to the babypips school or listened to any RSI expert, they would tell you that a bearish divergence forecast a reversal of an upward trend into a downward one. And a bullish divergence means the trend is about to become bullish.
As you can see here is a very strong bearish divergence on the weekly chart of USDCAD. You can clearly see how price completely ignored the divergence and made a higher high.
[B]That’s lesson no.1:[/B] A bearish divergence [B]confirms[/B] the uptrend. A bullish divergence [B]Confirms[/B] the down trend.
In other words, if you see a bearish divergence you should be more confident you will see [B]A new high.[/B] And if you see a bullish divergence you should be confident of seeing [B]a new low.[/B]
Now you need to use the parabolic SAR to help you locate divergences. The parabolic SAR are dots placed below and above prices depending on several factors I wont get into. You need to compare the RSI of areas above the dots with one another and the RSI of areas below the RSI with one another. But only the last two.
Note: for simplicity, let’s call areas where price is above dots as “bull” and areas where price is below dots as “bear.” We want to compare the most recent two bulls in search of bearish divergence and the most recent two bears in search for a bullish divergence.
It’s a bit tricky this part, but I hope the pictures makes it easier. Also looking at charts will help. I will have a tip on how to do it effectively but I’m not done yet.