FVG Entries in Conjunction with Divergence on the Relative Strength Index (RSI)

Setup Description

This strategy combines the power of Fair Value Gaps (FVGs) with a classic momentum indicator, the Relative Strength Index (RSI). Specifically, we are looking for FVG entries that are confirmed by divergence on the RSI. Divergence occurs when the price is making new highs or lows, but the RSI is failing to do so. This is a sign that the momentum behind the trend is fading and that a reversal is likely.

When an FVG forms in conjunction with RSI divergence, it creates a high-probability reversal setup. The FVG provides a precise entry point, while the RSI divergence provides the confirmation that the trend is exhausted. This strategy is particularly effective at identifying turning points in the market and can be used to trade both reversals and deep retracements.

Entry Rules

Long Entry:

1. Identify a clear downtrend on the 5-minute or 15-minute chart.
2. Look for bullish divergence on the RSI (14-period). This occurs when the price is making a new low, but the RSI is making a higher low.
3. Look for a bullish FVG to form after the divergence is confirmed.
4. The entry is triggered when the price retraces into the FVG.
5. A limit order is placed within the FVG.

Short Entry:

1. Identify a clear uptrend on the 5-minute or 15-minute chart.
2. Look for bearish divergence on the RSI (14-period). This occurs when the price is making a new high, but the RSI is making a lower high.
3. Look for a bearish FVG to form after the divergence is confirmed.
4. The entry is triggered when the price retraces into the FVG.
5. A limit order is placed within the FVG.

Example: Long Entry on QQQ

The Invesco QQQ Trust (QQQ) is in a downtrend on the 15-minute chart. The price makes a new low at $420, but the RSI makes a higher low, confirming bullish divergence. A bullish FVG then forms between $421 and $422. The price retraces to $421.50, and a long entry is taken.

Exit Rules

Profit Target:

• The primary profit target is the next significant resistance level (for longs) or support level (for shorts).
• A secondary target can be a 2R multiple of the initial risk.

Stop Loss:

• The stop loss is placed just below the low of the FVG for a long trade, or just above the high of the FVG for a short trade.

Profit Target Placement

Profit target placement for this strategy should be based on key support and resistance levels. The next significant level is the most logical target, as it represents the next area where the price is likely to react. You can also use a fixed risk-to-reward ratio, such as 2R, as a profit target.

Stop Loss Placement

The stop loss for this setup should be placed just beyond the FVG. A break of the FVG would invalidate the setup and signal that the trade should be exited. This placement provides a clear and objective point of invalidation for the trade.

Risk Control

• Max Risk Per Trade: Limit your risk to 1% of your trading capital per trade.
• Confirmation: Wait for the divergence to be clearly established before looking for an FVG.
• Timeframe: This strategy works best on the 5-minute and 15-minute charts.

Money Management

Position Sizing:

Use the standard position sizing formula, ensuring that your risk is in line with your overall risk management plan.

Scaling In/Out:

• Scaling In: Not recommended.
• Scaling Out: Consider taking partial profits at a key level and moving your stop to breakeven.

Edge Definition

The edge of this strategy comes from the confluence of a leading momentum indicator (RSI divergence) and a precise price action pattern (FVG). The RSI divergence gives us an early warning that the trend is about to reverse, while the FVG provides a high-probability entry point to capitalize on the reversal. This is a effective combination that can lead to high-probability trades with a favorable risk-to-reward ratio.

• Win Rate Expectation: This setup can achieve a win rate of 60-70%.
• Profit Factor: The expected profit factor is between 1.8 and 2.5.