How To Trade RSI And MACD Divergence

Divergence is undoubtedly one of the most effective trading patterns because it basically tells you when a trend is starting to run out of momentum. Therefore when it looks like a reversal is about to happen, you can have a great deal more confidence entering a trade at the start of this new trend.

These divergence patterns occur on every different time frame and they are fairly easy to spot. You can use a variety of different technical indicators to help you, but I personally think the RSI and MACD indicators are two of the best ones you can use for spotting these divergence patterns.

What you are basically looking for is for the price to be going up (and ideally making new highs), but for the RSI and MACD indicators to be failing to make new highs. The fact that these indicators are failing to make new highs tells you that the upward trend is running out of steam, and could be about to reverse.

Similarly if you are looking to go long in a downward trending market, you want the price to be making new lows, whilst the RSI and MACD indicators are both failing to make new lows.

I probably haven't explained that very well so let me give you two recent examples from the daily GBP/USD chart.

In the first example, indicated by points 1 and 2 you can see that when the price headed up towards 1.6750 (at point 2), both the RSI and MACD were lower than they were at point 1. Therefore although this wasn't a perfect divergence pattern because the price didn't actually make new highs, it was still an excellent trading signal to go short when the MACD crossed downwards (indicated by the red arrow).

The second example, indicated by points 3 and 4, was more of a classic divergence pattern because the price made a new low at point 4 but the RSI and MACD were actually higher at this point than they were at point 3. So this was another indication that this trend was running out of momentum, and indeed you can see that when the MACD crossed upwards (indicated by the green arrow), there was a very nice reversal to the upside.

So as I say, these divergence patterns happen on every different time frame and can be extremely profitable. However in my experience it's generally best to use them on the longer time frames so you avoid getting a lot of false signals.