The Relative Strength Index (RSI), developed by J. Welles Wilder, is a cornerstone of technical analysis and one of the most widely used tools in a technician’s toolbox. This momentum oscillator measures the speed and change of price movements, oscillating between 0 and 100, making it highly versatile for analyzing overbought and oversold conditions. Its appeal lies in its simplicity and effectiveness, offering insights into potential reversals and trend continuations by quantifying relative price strength. The RSI’s ability to pinpoint divergences and provide early signals of shifts in market sentiment cements its role as an indispensable tool for traders and analysts alike.

One of the most significant applications of the Relative Strength Index (RSI) is spotting divergences, which can signal potential trend reversals. A bullish divergence occurs when the RSI forms higher lows while the price charts lower lows, indicating weakening selling pressure and a possible upward reversal. Conversely, a bearish divergence arises when the RSI makes lower highs as prices reach higher highs, hinting at diminishing buying strength and an impending downturn. By identifying these divergences, traders can anticipate market shifts before they become evident on the price chart, enabling more timely entry and exit decisions. This early insight into potential reversals makes divergence analysis a vital tool for technical traders aiming to stay ahead of market movements.

To spot a bullish divergence, observe the price chart for lower lows while the RSI simultaneously forms higher lows, indicating a discrepancy between price action and momentum. This suggests that selling pressure is weakening, often interpreted as a potential reversal to the upside, signaling an opportunity to consider long positions or reduce bearish exposure.

If we apply this concept to a practical application, bullish divergence will be observed in TATAMOTORS. The recent months have been challenging for the markets, and there is no difference for this stock either. From its peak above Rs. 1177 to Rs. 754, the price at which it is trading, the stock has lost a significant value from its peak. However, the last phase of the downside has come with a difference.

The most immediate phase of the decline has come with  the RSI showing bullish divergence against the price. While the price formed a lower low, the RSI did not, and this led to the emergence of a bullish RSI divergence against the price.

Does this call for an entry in this stock?

The answer to this is a “yes,” but that comes with a caveat.

The right time to enter a stock after spotting a bullish divergence is when price confirmation aligns with the RSI signal. This typically occurs when the price breaks above a key resistance level, forms a higher high or shows a reversal candlestick pattern such as a bullish engulfing or hammer. Waiting for price confirmation helps validate the divergence and reduces the risk of acting prematurely in case of false signals.

In the present case, the most ideal point of entry would come once the stock crosses above Rs. 765 and stays above that. The crossing above Rs. 765 would mean penetrating the most immediate resistance level.

An entry above the mentioned levels would mean spotting a potential trend reversal early. By combining momentum signals with price confirmation, one can better position oneself to capitalize on opportunities and manage risks effectively. However, a close below most immediate low would negate this formation.

-Foram Chheda, CMT