A bearish divergence is when price action is making higher highs, but RSI is making lower highs. It means the rally is running out of steam.
It generally means the market is heading for a major selloff. Have a look:
Since early 2018, the S&P 500 has been making higher highs, but the RSI has been making lower highs. This is a long-term bearish RSI divergence. This is over three years in the making now.
We also saw this on a smaller scale from about June 2014 to May 2015. The S&P was making new highs, while the RSI was deteriorating. It eventually led to a sharp correction in August 2015, followed by a “double-dip” in January 2016.
We didn’t see much of a bearish divergence in 2007-2008. The market peaked right when RSI peaked, and things went south rather quickly from there.
However, we did see long-term bearish RSI divergence in the late 1990s. The S&P made new highs from July ’97 to March ’00, while the RSI steadily made lower highs over that same time period. So the divergence lasted almost three years, which is right around where we’re at now.
If we look even further back on the chart, we can see a couple more examples of bearish RSI divergence:
February ’87 to August ’87 we had new index highs but lower highs in the RSI. That preceded the infamous crash of ’87.
And we also had a bearish divergence from early 1971 until early 1973, which as we know gave way to the bear market of ’73-’74. That ended up being a 49% decline.
The takeaway here is that the longer the divergence lasts, the worse the bear market is going to be.
Now, there are not a ton of prior examples here so we can’t draw anything conclusive from this, but historically the bearish RSI divergence has preceded chaos in the market.