When an asset enters a bearish phase and headlines are negative, analysts anticipate further downside, and sentiment shifts from optimism to pure gloom and doom. This results in panicked traders dumping their positions near the bottom of the downtrend instead of buying.
How can traders go against the herd and build up the buying courage in a bear market? This is not easy because if they buy too early, the situation can quickly turn into a loss. However, if they wait too long, they may miss the opening part of the rally.
Although it is difficult to pull the trigger during a bear phase, the Relative Strength Index (RSI) indicator can identify market bottoms and favorable risk to reward scenarios.
Let’s review some examples of when to buy in a bear market.
Look for highly oversold levels on the RSI
bitcoin (B T c) reached near $20,000 in December 2017 and started a long gut-wrenching bear market near $3,300 in December 2018. During this period, the RSI entered oversold territory (reading below 30) on five occasions (on the chart marked as ellipsis).
In the first four instances, the RSI fell near or below the 30 level, but for the fifth time, the RSI dropped to 10.50. This is a sign of capitulation, where traders who were buying pre-emptive bottoms or holding positions in a bear market succumbed to fear and purged their holdings.
Typically, long bear markets end after a long period of fear-based selling. Smart traders wait for these opportunities and buy when the market is overbought, such as when the RSI is below 20.
Fast forward to 2019 and 2020 when the RSI fell near 20 on two occasions and fell to 15.04 on March 12, 2020.
The first example when the pair fell to 19.60 on September 26, 2019, turned out to be a loss trade as the price made a new local low week on October 23, 2019. This suggests that traders should be prepared for their closes. There are positions when stops are hit because if they don’t, the losses can continue to mount.
On November 24, 2019, the RSI dropped to 22.32, just above the 20 level. For traders who place very tight stops, this would have turned into a loss-making trade with the fall on December 18, 2019. However, these were all small losses that would not make a dent in the portfolio as long as the traders were not. Using heavy leverage.
The RSI fell to 15.04 on March 12, 2020, and traders brave enough to buy after this fall will have made outside gains to hold their positions during the bull phase, which peaked at $64,854 on April 14, 2021. was up. Shows how after two losers, traders finally hit the jackpot using the RSI signal.
Combination of RSI with moving average produces a better signal
during the ether (ETH) Bear phase in 2018, there were four instances when the RSI fell below or near the 20 level. The first opportunity offered traders a strong return but the other two examples proved to be losers.
To avoid whipsaws, traders can add additional filters to protect them from losing trades. A simple example might be that instead of buying just after the RSI drops below 20, traders can wait for the price to close above the 20-day exponential moving average for three consecutive days before buying.
As seen in the chart above, a buy signal started in April 2018 when the ETH/USDT pair rose above the 20-day EMA on the RSI after falling below the 20 level. This trade turned out to be profitable as the pair saw a sharp increase.
The next buy signal in August did not meet the criteria as the price did not move above the 20-day EMA for three consecutive days. The third trade in September would have turned a minor loss but made a huge profit in November.
Bullish Divergence and How to Spot Them
Another important tool that can help warn traders of a potential trend reversal is a bullish divergence. This occurs when the price continues to decline but the RSI makes higher lows, indicating that bearish momentum may be weakening.
Litecoin (LTC) shows the formation of two bullish divergences during the 2018 bear phase. The first divergence from August to September of 2018 turned out to be a false signal as the price did not rise above the swing high.
However, the second bullish divergence from November to December 2018 proved to be a profitable downside signal, which was followed by a sharp rise over the next few days.
Another example of a slightly longer bullish can be seen in Ethereum Classic (etc) from September to December 2019. During this period, the price made lower lows but the RSI formed higher lows. The ETC/USDT pair rose in the coming days after breaking above swing highs.
VeChain (veterinary doctor) also showed the formation of a bullish divergence from September 2020 to October 2020, which was followed by a major bull run. This shows that Bullish Divergence is a useful tool that, if used wisely, can be of great benefit to traders.
some important measures
Bear markets provide an opportunity to buy an asset at a significant discount but it is not easy to buy when everyone is selling and sentiment is negative.
However, traders using the RSI can get an edge. Excessively oversold readings on the RSI are a sign of capitulation, which usually marks the end of a bear phase. This strategy can help traders pull the trigger when it matters.
Sometimes, the RSI can give false signals, therefore, traders can use additional filters such as above the daily 20- and 50-day moving averages to avoid whopping trades. Detection of a bullish divergence can also alert traders that a downtrend may be over.
The views and opinions expressed here are solely those of the author and do not necessarily reflect the views of Cointelegraph.com. Every investment and trading move involves risk, so you should do your own research when making a decision.