When an asset enters a bear phase and the headlines are unfavorable, analysts project further downside, and the opinion shifts from optimism to pure gloom and doom. This ends in panic gripped traders ditching their positions close to the base of the downtrend instead of purchasing.
How can traders move against the herd and build the guts to purchase in a bear market? It’s not easy because if they buy too early, the place may quickly become a loss. However, if they wait for a long time, they might miss the early part of the rally.
Although pulling the trigger in a bear phase is difficult, the relative strength index (RSI) indicator can identify market bottoms and favorable risk to reward situations.
Let’s review a few examples of when to purchase in a bear market.
Bitcoin (BTC) topped out close to $20,000 at December 2017 and began a very long gut-wrenching bear market that bottomed out near $3,300 at December 2018. During this period, the RSI entered the oversold territory (a reading below 30) on five occasions (marked as ellipses on the graph ).
At the first four cases, the RSI dipped close to or just below the 30 level but during the fifth period, the RSI dropped to 10.50. This is a sign of capitulation where dealers who had been purchasing pre-empting a bottom or had held their positions in the bear market succumbed to panic and purged their holdings.
Normally, long bear markets end after protracted intervals of fear-based selling. Bright traders wait for all these opportunities and purchase when the markets are deeply oversold, such as when the RSI below 20.
Fast forward to 2019 and 2020 if the RSI dipped close to 20 on two occasions and dropped into 15.04 on March 12, 2020.This demonstrates that traders must be ready to close their positions when the stops hit because if they don’t do this, the losses will keep growing.On Nov. 24, 2019, the RSI dropped to 22.32, only above the 20 level. For dealers who keep a very tight stop, this would have also turned out to be a losing trade together with the fall on Dec. 18, 2019. However, these were all small losses, which would not make a dent into the portfolio unless dealers were using heavy leverage.The RSI plunged to 15.04 on March 12, 2020, and dealers who were brave enough to purchase after this fall would have made outsized gains had they held onto their positions during the bull period, which topped out at $64,854 on April 14, 2021. This reveals how after two losing purchases, traders eventually hit the jackpot using the RSI signal.
Combining the RSI with moving averages creates a much better sign
Throughout Ether’s (ETH) bear period in 2018, there were four cases if the RSI dipped below or arrived close to the 20 level. The first chance offered a powerful return to dealers but another two cases turned out to be winners.
To avoid whipsaws, traders may add more filters to keep them out of losing trades. One simple example could be that instead of purchasing only after the RSI drops below 20, traders may await the cost to close above the 20-day exponential moving average for three successive days before purchasing.
As seen in the graph above, the signal to purchase in April 2018 triggered as the ETH/USDT pair rose above the 20-day EMA after dropping below the 20 flat on the RSI. This trade was be rewarding as the pair seen a sharp up-move.
The following buy signal in August did not meet the criteria because the price did not rise above the 20-day EMA for three consecutive days. The next trade in September would have turned into a minor loss however, the one in November would have made a massive profit.
Bullish divergences and how to spot them
Another important tool which can help warn traders of a potential trend reversal is a bullish divergence. This occurs when the cost continues to drop but the RSI makes greater highs, indicating the bearish momentum could be weakening.
Litecoin (LTC) reveals the creation of two bullish divergences during the 2018 bear phase. The first divergence that formed from August to September of 2018 turned out to be a false signal because the price did not rise above the swing high.
However, the 2nd largest divergence from November into December of 2018 turned out to become a rewarding signal right at the base, which was followed by a sharp increase within the next few days.
Another example of a slightly longer bullish divergence can be seen at ETH Classic (ETC) from September to December 2019. Throughout the time, the cost made lower lows however, the RSI formed greater highs. The ETC/USDT pair surged in the next few days when it broke above the swing high.
VeChain (VET) also revealed the creation of a bullish divergence from September 2020 into October 2020, which was followed by a massive bull run. This reveals the bullish divergence is a helpful instrument, which if used sensibly can benefit the dealers hugely.
Some important takeaways
Bear markets offer the chance to purchase an asset at a considerable discount but it is not easy to buy when everybody is selling and the opinion is negative.
However, traders who use the RSI can develop an edge. A very oversold reading about the RSI is a sign of capitulation, which normally marks the end of a bear phase. This strategy can help traders pull on the trigger when it matters.
Sometimes, that the RSI may provide false signals, therefore, traders may use extra filters such as daily closes above the 20- and 50-day moving average to prevent whipsaw trades. Spotting bullish divergences may also alert traders a downtrend might be ending.
The views and opinions expressed here are only those of the author and do not necessarily reflect the views of Cointelegraph.com. Every single investment and trading proceed entails risk, you should run your own research after making a determination.
Knowing how to identify market reversals and if to get the dip is almost impossible, however, the RSI indicator can help.