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Trading Guide

Your guide to financial freedom
I.1. Trend strength

Look at the following scheme.

1. Buyers believe that the trend has recovered, or a new trend has begun and they want to make money. So they open long positions and drive the price higher. The trend accelerates as more buyers jump into the market.

2. When the buyers take profits, the trend weakens. Buyers still dominate, but they calm down because they are afraid that the trend is coming to the end.

3. When there are no more buyers in the market, the trend is going to reverse. Sellers dominate.

Our goal is to find the point where the trend is so weak that it is probably going to reverse.
A good tool helping us to measure the character of the trend is the RSI indicator (Relative Strength Index).



“When the RSI rises above 70, the market is considered to be overbought. When the RSI falls below 30, the market is considered to be oversold.” This is a good old story, but we will use the RSI indicator another way.

 What is a divergence?

Now, look at the same chart again.

There are two significant highs labeled “A” and “B” in the price chart and the corresponding highs in the RSI chart. In the price chart, we see that B is higher than A. That means that the price is still going up. In the RSI chart, it's just the opposite: B is lower than A. It means that the trend weakens and it is probably going to reverse. And the trend has actually reversed!

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