A strong and pretty much uninterrupted rally since late August has left the GBPUSD chart looking as though it might give divergence traders a sell set up before too long.

Bearish Divergence

Since late August, the angle of the uptrend has steepened with price now well above the underlying trend line.

What will now interest divergence traders, is that there looks like a real chance that while the next peak in price will be considerably higher than the last one, oscillators will be making lower highs.

I've shown how this might be starting to pan out using a 14 day RSI on the chart below

GBPUSD CFD Daily Chart

GBPUSD RSI Divergence GBPUSD RSI Divergence

Bearish Divergence Entry Strategy

One approach to trade entry for bearish divergence with the RSI, is to sell when there is divergence followed by a failure swing in the RSI. Under this approach, a trader would sell to open after the following conditions are met:

  • The price chart completes a trend peak that is higher than the previous peak
  • The first price peak results in an RSI peak above the 70% overbought line
  • The 2nd price peak results in a lower RSI peak. This means there is divergence between price and the RSI. Price is still making higher highs but the RSI is now making lower highs.
  • After this divergence, the RSI moves below its most recent trough or support. This support is shown as the dashed line on the chart and should be below the 70% line. Breach of this support means the RSI has completed a "failure swing". It is now making both lower highs and lower lows i.e. it is trending down.

The RSI uses the closing prices of each candle for its calculation. This means you can't always be certain that a failure swing has been completed until after the candle closes. For that reason and to make time management of the trade easier, one approach is to enter at the next day's opening once the failure swing has been completed.