RSI divergence confirmed in a NEPSE stock!

This Nepse stock has lost 836 points since its recent high. It is trading at around 1350 today. The freefall is may due to some change in company fundamentals such as announcement of cash dividend, bonus share or some economic event, but it has been observed week before stock price tumbles in a technical indicator called Relative Strength Index or RSI. Sounds interesting?

Relative Strength Index (RSI), which is developed by J., W. Wilder, is a technical momentum indicator and measures speed and change in price movements. This extremely popular leading indicator work best in the sideways market however, it can be used to study the change of balance of power between bull and bear in market tops and bottoms. RSI oscillates between 0 and 100 in the as shown in the chart. Value of the RSI shows the sentiment of bull and bears for that stock. If RSI becomes greater than 70, it is said to be overbought and oversold if less than 30. The balance of power between bull and bear equals when RSI closes to 50 and the power shifts from bull to bear vice versa when it rises and fall from that level. 

In normal market conditions, RSI usually confirm price. In above chart, RSI confirms stock price for 75 trading days. For example, when RSI rises from 48 to 94 during 37^th and 45^th trading day, stock price also increases from 1650 to 2150 and it moved with RSI until 74^th trading day. RSI divergence cropped up after 75^th day of trading. RSI doesn’t confirm the price afterwards. As we can see in the chart, our mysterious NEPSE stock makes new high (2250) in 77^th trading day. At the same time, RSI makes lower high than previous high (approx 65). This is known as Bearish Divergence. It occurs when the stock makes higher high but RSI makes a lower high. It is found out by joining the tops of RSI highs and stock highs as shown in the dotted line in the chart. In this stock, Bearish Divergence was observed in 77^th trading day. This stock lost 40% of its value afterwards. Bearish Divergence signals the change of sentiments of bulls and offers the best selling opportunity for traders. The use of RSI or other momentum indicator such as Stochastic, or MACD can help identify such opportunity. 

Next time when you see the RSI divergence in the bull market, don’t rush to buy at higher price. You can buy cheaper in the dip. Happy investing!