I've spent years watching traders obsess over the RSI as if it were the magic solution to making money in the stock market. The reality is that it works, but only if you understand it well and combine it with other tools. Today I will break down what this indicator really does and, more importantly, how RSI divergences can anticipate movements that the price has not yet shown.

Let's start with the basics. The RSI or Relative Strength Index measures momentum by comparing bullish closes against bearish closes over a certain period. The formula normalizes this on a scale from 0 to 100, making it very practical. When you see the RSI above 70, the asset is overbought. Below 30, it is oversold. But here’s what many ignore: an asset can remain overbought or oversold for weeks if the fundamentals justify it.

I saw this clearly with Tesla between 2019 and 2022. In May 2019, it was in extreme oversold territory, but when it moved out of that zone, it wasn’t the end of the world. The price simply corrected and then continued upward. The RSI reached overbought in February 2020 when COVID arrived, but again, it was just a temporary correction within a larger bullish trend. The key was to observe whether the indicator returned to its mid-zone or not. As long as it didn’t cross that 50 level, it remained a pure bullish trend.

Now, what really changes the game are RSI divergences. This is the concept that separates mediocre traders from those who understand the market. A bullish divergence occurs when the price makes lower lows but the RSI makes higher lows. It’s as if the indicator is telling you: hey, selling is losing strength, something is about to change. The opposite happens with bearish divergences: the price hits higher highs but the RSI fails to surpass itself. That’s a sign of latent weakness.

Look at the case of Broadcom a few years ago. The chart showed clear descending lows, typical of a downtrend. But the RSI was making higher lows in oversold territory. That was a textbook bullish divergence. Two months later, the price surged upward. With Disney, the opposite happened: higher highs in price but lower highs in RSI. It was a bearish divergence screaming that something was wrong. The decline came and lasted over a year.

The reason RSI divergences work is that oscillators are leading indicators. The RSI detects momentum changes before the price reflects them. It’s like having a radar that detects direction changes before they happen. Of course, it’s not infallible, but combined with trend analysis, it has a pretty respectable success rate.

To further strengthen your signals, many traders like me combine RSI with MACD. The idea is to wait until RSI reaches extreme zones, then confirm the change in direction with MACD crossing its midline. That way, you have two confirmations instead of one. I saw this years ago in Block Inc.: RSI in overbought territory, then MACD crossing downward, and that was the signal to go short. The trade lasted four months until MACD made a bullish crossover. Profit confirmed.

The important thing is not to obsess over a single tool. RSI gives you signals, RSI divergences give you warnings of imminent change, but the final validation must come from breaking a trendline. Without that, you’re trading in the void. Combine indicators, respect trends, and wait for confirmations. That’s how you play this game long-term.