Divergences are one of the most reliable trading concepts that provide very good buy/sell opportunities. Though it belongs to  classical technical analysis, yet it is widely used by modern hedge fund trading systems. In a very layman term, divergences are said to happen when price and momentum does not confirm the same direction. For ex:- if price is going up but momentum is going down or vice versa. There are various momentum based indicator available through which you can quantify divergences. In this post, we will go through a RSI Divergence Trading System. This system has a very high success rate and the credit for its development goes to Brad Konia, who has uploaded it in WiseStockTrader. We have added Buy/Sell signals to this systems and made it back-testable.

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RSI Divergence

RSI Divergence occurs when price and RSI does not move in same direction. If Price is going up and RSI is going down it’s called Bearish RSI Divergence, while if price is going down and RSI is going up it’s called Bullish RSI Divergence. The below image explains it in a better way:

The next section is going to describe Amibroker AFL code for RSI Divergence Trading system. This system has unbelievable profit potential. In a sample backtest for 16 years, it shows 100% success rate for NSE Nifty. Even for other scrips it performs exceptionally well.

AFL Overview

Parameter	Value
Preferred Time-frame	Daily
Indicators Used	RSI(14)
Buy Condition	RSI Bullish Divergence
Short Condition	RSI Bearish Divergence
Sell Condition	New peak formation in RSI chart
Cover Condition	New Trough formation in RSI chart
Stop Loss	No fixed stoploss
Targets	No fixed target
Position Size	150 (fixed)
Initial Equity	200000
Brokerage	100 per order
Margin	10%

AFL Code

Note: This AFL uses Zig Zag indicator which makes it prone to look into future. While its good for backtesting purpose, we do not recommend to use the buy/sell signals for live trading.

//------------------------------------------------------
//
//  Formula Name:    RSI Divergance
//  Author/Uploader: Brad Konia
//  E-mail:          support@tradingtuitions.com
//  Website:         www.tradingtuitions.com
//------------------------------------------------------

SetChartOptions(0,chartShowArrows|chartShowDates);
_N(Title = StrFormat("{{NAME}} – {{INTERVAL}} {{DATE}} Open %g, Hi %g, Lo %g, Close %g (%.1f%%) {{VALUES}}", O, H, L, C, SelectedValue( ROC( C, 1 ) ) ));
Plot(Close,"Price",color=colorBlue,style=styleCandle);


SetTradeDelays( 1, 1, 1, 1 );
SetOption( "InitialEquity", 200000);
SetOption("FuturesMode" ,True);
SetOption("MinShares",1);
SetOption("CommissionMode",2);
SetOption("CommissionAmount",50);
SetOption("AccountMargin",10);
SetOption("RefreshWhenCompleted",True);
SetPositionSize(150,spsShares);
//SetPositionSize(20,spsPercentOfEquity);
SetOption( "AllowPositionShrinking", True );

 
indName = "RSI"; // Specify the name of the indicator. This is cosmetic only.
length = Param(indName + " Length", 14, 8, 100, 1); // Indicator length
threshold = Param("Zig/Zag Threshold %", 10, 1, 50, 1); // Minimum % change in indicator value to be considered a zig/zag
indVal = RSI(length); // Load the indVal array with the values from the indicator of your choice
indZig = Zig(indVal, threshold); // Set the zig/zag values for the indicator
indPeakVal1 = Peak(indVal, threshold, 1); // Most recent peak value
indPeakBars1 = PeakBars(indVal, threshold, 1); // Bars since most recent peak
indPeakVal2 = Peak(indVal, threshold, 2); // Second most recent peak value
indPeakBars2 = PeakBars(indVal, threshold, 2); // Bars since second most recent peak
indTroughVal1 = Trough(indVal, threshold, 1); // Most recent trough value
indTroughBars1 = TroughBars(indVal, threshold, 1); // Bars since most recent trough
indTroughVal2 = Trough(indVal, threshold, 2); // Second most recent trough value
indTroughBars2 = TroughBars(indVal, threshold, 2); // Bars since second most recent trough
 
// Determine if current bar is a peak or trough
peakBar = indPeakBars1 == 0;
troughBar = indTroughBars1 == 0;

printf("\n peakBar  : " + peakBar ); 
printf("\n troughBar  : " + troughBar ); 

 
// Bearish divergence
divergeBear = IIf(peakBar AND (indPeakVal1 < indPeakVal2) AND High > Ref(High, -indPeakBars2), True, False);
Short=divergeBear;
Cover=troughBar;
Short=ExRem(Short,Cover);
Cover=ExRem(Cover,Short);
 
// Bullish divergence
divergeBull = IIf((indTroughBars1 == 0) AND (indTroughVal1 > indTroughVal2) AND Low < Ref(Low, -indTroughBars2), True, False);
Buy=divergeBull;
Sell=peakBar;
Buy=ExRem(Buy,Sell);
Sell=ExRem(Sell,Buy);

printf("\n divergeBear  : " + divergeBear ); 
printf("\n divergeBull  : " + divergeBull ); 

BuyPrice=Open;
SellPrice=Open;
ShortPrice=Open;
CoverPrice=Open;

printf("\nBuy : " + Buy );  
printf("\nSell : " + Sell );  
printf("\nShort : " + Short );  
printf("\nCover : " + Cover );  
 

/* Plot Buy and Sell Signal Arrows */
PlotShapes(IIf(Buy, shapeSquare, shapeNone),colorGreen, 0, L, Offset=-40);
PlotShapes(IIf(Buy, shapeSquare, shapeNone),colorLime, 0,L, Offset=-50);
PlotShapes(IIf(Buy, shapeUpArrow, shapeNone),colorWhite, 0,L, Offset=-45);
PlotShapes(IIf(Cover, shapeSquare, shapeNone),colorGreen, 0, L, Offset=-40);
PlotShapes(IIf(Cover, shapeSquare, shapeNone),colorLime, 0,L, Offset=-50);
PlotShapes(IIf(Cover, shapeUpArrow, shapeNone),colorWhite, 0,L, Offset=-45);
PlotShapes(IIf(Sell, shapeSquare, shapeNone),colorRed, 0, H, Offset=40);
PlotShapes(IIf(Sell, shapeSquare, shapeNone),colorOrange, 0,H, Offset=50);
PlotShapes(IIf(Sell, shapeDownArrow, shapeNone),colorWhite, 0,H, Offset=-45);
PlotShapes(IIf(Short, shapeSquare, shapeNone),colorRed, 0, H, Offset=40);
PlotShapes(IIf(Short, shapeSquare, shapeNone),colorOrange, 0,H, Offset=50);
PlotShapes(IIf(Short, shapeDownArrow, shapeNone),colorWhite, 0,H, Offset=-45);

_SECTION_END();

RSI Divergence Trading System: Screenshot

RSI Divergence Trading System: Backtest Report

Parameter	Value
	Fixed Position Size
Initial Capital	200000
Final Capital	2425937
Scrip Name	NSE Nifty
Backtest Period	08-Mar-2000 to 11-Aug-2016
Timeframe	Daily
Net Profit %	1112.97%
Annual Return %	16.12%
Number of Trades	88
Winning Trade %	100%
Average holding Period	7.09 periods
Max consecutive losses	0
Max system % drawdown	-4.83%
Max Trade % drawdown	-37.3%

Th Annual return can increase multi-fold if you allow compounding. Download the detailed backtest report here.

Equity Curve

Profit Table

Additional Amibroker settings for backtesting

Goto Symbol–>Information, and specify the lot size and margin requirement. The below screenshot shows lot size of 75 and margin requirement of 10% for NSE Nifty:

Check out our other profitable Trading systems in the below link:

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