RSI (ii)

<<<<<<< HEAD

Previous...


How it Works and Trading The RSI within a Range

As with many oscillators the RSI works best in a range. This chart happens to be a horizontal range, but RSI also works well in trending channel creating consolidation points before the trend continues again. In strong trending markets the RSI tends to fluctuate at higher levels, like 40 to 90. We discuss The RSI indicator in trending markets in the below section. 

As we’ve mentioned when the RSI is below 30 or above 70 the market is oversold or overbought and traders are going to look for a price reversal at some point. In our below chart we’ve plotted the RSI against a daily chart of The Nasdaq. The period we’re looking at is from Mar 2011 to Jul 2011 and you can see we’re trading in a horizontal range with good support and resistance levels. To the far left (1) we have an overbought indicator where The RSI almost hit 90, then a bearish retracement. I've highlighted several overbought and oversold positions, most signal a retracement within the channel, but some were false signals, like (2) circled in June. Despite this oversold indicator the index continued it’s bearish trend until it hit support at 2600, when it turned – reversal and retracement can be a process taking a few signals to happen. 

I hope you can see how a trader can use the RSI in a ranging market?  Our example is a large 300 point range, so buying at the bottom of the range and selling at the top of the range looks very profitable when buying on these oversold signals and selling on overbought signals.  When looking for overbought and oversold stocks traders should first see how the overall market is doing. I.e. if FTSE is thought to be overbought then drill down into individual stocks with high RSI readings to trade.

Nasdaq - RSI overbought and oversold signals

RSI Range Trade (simple strategy):
  • General Parameters set at RSI (14) on a daily chart
  • Buy trigger - Enter the trade long (buy) when RSI crosses above 30 
  • Sell Trigger - Sell when RSI crosses above 70
  • Short Trigger - Enter the trade short when RSI crosses below 70
  • Sell the Short Trigger - Sell when RSI crosses below 30
  • Our stop/loss is placed just below support or resistance highlighted by trend lines
  • Risk Reward Ratio: Generally traders look for 2:1 or 3:1. We'll look at risk reward in later modules
As always other indicators (like moving averages), volume and economic news will help with our trading strategy. If using an RSI some traders find it useful to make their trading decisions along with other indicators like the moving average crossover. A 10-day and 25-day MA crossover may be useful when using the RSI (14). I.e. when the 10-day MA crosses below the 25-day MA and the RSI indicates overbought this may be a good short signal.

Trading The RSI in a Trend

The RSI tends to work in a very predictable way in a strong bull or bear market. In a strong up trend the RSI tends to fluctuate between 40 and 90 with the 40 to 50 RSI “zone” acting as support. These ranges are based on the RSI 14 and will change depending on the RSI period, the strength of the trend and the securities volatility. 

In our below chart of The S&P 500 we are showing an upward trending market with consolidation periods along support. You’ll notice that the RSI surges above 70 on 5 occasions and holds it’s 40 to 50-zone quite consistently. However it did hit 34.46 in Nov 09. Nevertheless the 40-50 support level held for 5 ½ months. This support zone provides “lower risk” entry points to the market when it’s in a strong up trend.  Notice how the RSI dips below the support zone and through 30, once the market breaks support.

S&P 500 - How the RSI works in an Up Trend

RSI Trend Trade  - always go with trend (simple strategy):
  • General Parameters set at RSI (14) on a daily chart
  • Up trend Buy trigger - Enter the trade long (buy) when RSI crosses above 40 or 50
  • Up trend Sell Trigger - Sell when RSI crosses above 80 or 90
  • Down trend Short Trigger - Enter the trade short when RSI crosses below 50 to 60
  • Down trend Sell the Short Trigger - Sell when RSI crosses below 10 and 20
  • OR, don't sell and keep long/short position until an RSI divergence precedes the above sell triggers.
  • Set a trailing stop 2% behind the trade to lock in profits.  We'll talk trailing stops in later modules
  • Our stop/loss is placed just below support highlighted by trend lines
  • Risk Reward Ratio: Generally traders look for 2:1 or 3:1. We'll look at risk reward in later modules
In a down trend RSI tends to fluctuate between 10 and 60 with resistance levels between 50 and 60. Again, these ranges will change depending on timeframe, RSI period and the strength of the downtrend. I’ve charted the USD/CHF below showing the resistance level providing entry-level points of which there are 4 plus two touching 50.  To Trade this down trend traders will always follow the trend. Instead of entering at the 30 or 70 signal as they would in a range, the entry point will be as the RSI dips below 60 or 50. This really depends on how strong the trend is and what your trading strategy will be.  It also depends on your RSI settings, i.e. an RSI 5 will be more sensitive than an RSI 20, so the entry trigger will be higher.  In the below case I've highlighted short positions as the market dips below 50.

USD/CHF - How the RSI works in a Down Trend

RSI Indicator Divergence & Convergence 

The RSI divergence & convergence has similar trading properties to The MACD divergence & convergence, i.e. if theRSI is trending in the opposite direction to the price then this is an indication that there may be a price momentum reversal imminent. It's a trend reversal early warning system.  A Convergence is in many cases the forerunner to a bullish price momentum reversal, while a divergence is thought to be the forerunner to a bearish price momentum reversal. These moves tend to be more robust when they cross the overbought and sold line

Below in our RSI divergence chart of S&P 500 we have shown an example of a bearish divergence, where the price mechanism shows higher highs and RSI records lower peaks. These lower peaks in the RSI hints that weakening momentum in the upward price push is unfolding and that price may reverse. We can see this unfold below.  As this divergence is an early warning (leading indicator) a good entry point will be the next 70 line crossover after the divergence - Highlighted below.  

S&P 500 - RSI Negative (bearish) Divergence

RSI divergence indicators work best in ranging markets and can be traded as the "RSI Range Trade" in the "How it Works and Trading The RSI within a Range" section. However they can be used in trending markets.  Remember, always trade with the trend, so in an up trend many RSI divergences will signal a retracement (secondary trend), where traders can sell long positions (if this is part of their strategy). However, a full blown reversal may result after a divergence starting a new trend. Trade it as per "RSI Trend Trade" in the section "Trading The RSI in a Trend".  Be careful though.  The divergence doesn't always show a retracement or reversal.  In a strong up trend the price momentum may still go up.

bullish convergence happens when the RSI forms higher troughs while the price forms lower troughs.Again, this convergence is more robust when crossing the oversold indicator at 30.  This convergence suggests that downward price momentum is waning and a change in trend to the upside is possible.  Other indicators such as volume decreases, moving average convergence and support and resistance levels will also be useful in determining momentum shifts.

Trading the RSI  - Short-term Scenario

Day traders (Intra-day traders) and Swing traders (1 to 5 day horizon) can amend the RSI from 14 down to 2, 3, 4, 5 etc... When looking at RSI (2) overbought and oversold positions may only stay for up to an hour or a day, so it’s really only used for these short-term trades of 1 to 5 days. Since shorter period RSI’s are more volatile than longer period RSI's the overbought and oversold parameters must be changed away from 30 and 70.  For instance they may be moved to 5-10 for oversold and 90-95 for overbought. Each market and situation will have to tweak these parameters and some historical profiling will help set them as part of a trading strategy.

Below is how a Swing Trader may use the RSI
  • Analyse the longer trend using Moving averages, Peak trough analysis, support and resistance etc...
  • General rule - Trade with the trend
  • Drill into the market with a 15 minute chart
  • Use scanning packages to see where RSI is crossing signals
  • Set at RSI (5) on the chart.  Remember the RSI 5 is more sensitive than RSI 14
  • Buy trigger - Enter the trade long (buy) when RSI crosses above 30 or 40
  • Sell Trigger - Sell when RSI crosses above 70 or 80.  
  • Or buy, sell vice-versa if in a down trend
  • If there's major resistance prior to this trigger, then sell
  • A stop/loss is placed just below support or resistance highlighted by trend lines.  This could be no more than a 2% loss.
  • Risk Reward Ratio: Generally traders look for 2:1 or 3:1. We'll look at risk reward in later modules
This sequence will be a part of their over all trading set-up and strategy.

To Sum Up

The RSI is a standard component on any basic technical chart. The relative strength indicator focuses on the momentum underlying the security and is a great secondary measure to be used by traders. It is important to note that the RSI is often not used as the sole generation of buy-and-sell signals but used in conjunction with other indicators and chart patterns.

As we've seen, we can set the indicators price action sensitivity. The sensitivity of the indicator determines how quickly the trader enters the move and how accurate these trading signals are. If the indicator is set to low sensitivity then you generate less false signals, but you may see the move too late, or not see it at all. With high sensitivity you are more likely to catch the move into the trade, but you may generate false trading signals. For instance a swing trader (trading with a horizon of 4 to 5 days) may set the RSI to 3or 5 once they've drill down to an hourly chart from a daily chart. Good charting software will allow the parameters to be changed.

Technical analysis is not an exact science and although these indicators can increase the probability of making the correct trade, many will go against you and large losses can be incurred. Your own trading strategy needs to be formed and hopefully you'll be on your way to achieving this on completion of this course.

=======

Previous...


How it Works and Trading The RSI within a Range

As with many oscillators the RSI works best in a range. This chart happens to be a horizontal range, but RSI also works well in trending channel creating consolidation points before the trend continues again. In strong trending markets the RSI tends to fluctuate at higher levels, like 40 to 90. We discuss The RSI indicator in trending markets in the below section. 

As we’ve mentioned when the RSI is below 30 or above 70 the market is oversold or overbought and traders are going to look for a price reversal at some point. In our below chart we’ve plotted the RSI against a daily chart of The Nasdaq. The period we’re looking at is from Mar 2011 to Jul 2011 and you can see we’re trading in a horizontal range with good support and resistance levels. To the far left (1) we have an overbought indicator where The RSI almost hit 90, then a bearish retracement. I've highlighted several overbought and oversold positions, most signal a retracement within the channel, but some were false signals, like (2) circled in June. Despite this oversold indicator the index continued it’s bearish trend until it hit support at 2600, when it turned – reversal and retracement can be a process taking a few signals to happen. 

I hope you can see how a trader can use the RSI in a ranging market?  Our example is a large 300 point range, so buying at the bottom of the range and selling at the top of the range looks very profitable when buying on these oversold signals and selling on overbought signals.  When looking for overbought and oversold stocks traders should first see how the overall market is doing. I.e. if FTSE is thought to be overbought then drill down into individual stocks with high RSI readings to trade.

Nasdaq - RSI overbought and oversold signals

RSI Range Trade (simple strategy):
  • General Parameters set at RSI (14) on a daily chart
  • Buy trigger - Enter the trade long (buy) when RSI crosses above 30 
  • Sell Trigger - Sell when RSI crosses above 70
  • Short Trigger - Enter the trade short when RSI crosses below 70
  • Sell the Short Trigger - Sell when RSI crosses below 30
  • Our stop/loss is placed just below support or resistance highlighted by trend lines
  • Risk Reward Ratio: Generally traders look for 2:1 or 3:1. We'll look at risk reward in later modules
As always other indicators (like moving averages), volume and economic news will help with our trading strategy. If using an RSI some traders find it useful to make their trading decisions along with other indicators like the moving average crossover. A 10-day and 25-day MA crossover may be useful when using the RSI (14). I.e. when the 10-day MA crosses below the 25-day MA and the RSI indicates overbought this may be a good short signal.

Trading The RSI in a Trend

The RSI tends to work in a very predictable way in a strong bull or bear market. In a strong up trend the RSI tends to fluctuate between 40 and 90 with the 40 to 50 RSI “zone” acting as support. These ranges are based on the RSI 14 and will change depending on the RSI period, the strength of the trend and the securities volatility. 

In our below chart of The S&P 500 we are showing an upward trending market with consolidation periods along support. You’ll notice that the RSI surges above 70 on 5 occasions and holds it’s 40 to 50-zone quite consistently. However it did hit 34.46 in Nov 09. Nevertheless the 40-50 support level held for 5 ½ months. This support zone provides “lower risk” entry points to the market when it’s in a strong up trend.  Notice how the RSI dips below the support zone and through 30, once the market breaks support.

S&P 500 - How the RSI works in an Up Trend

RSI Trend Trade  - always go with trend (simple strategy):
  • General Parameters set at RSI (14) on a daily chart
  • Up trend Buy trigger - Enter the trade long (buy) when RSI crosses above 40 or 50
  • Up trend Sell Trigger - Sell when RSI crosses above 80 or 90
  • Down trend Short Trigger - Enter the trade short when RSI crosses below 50 to 60
  • Down trend Sell the Short Trigger - Sell when RSI crosses below 10 and 20
  • OR, don't sell and keep long/short position until an RSI divergence precedes the above sell triggers.
  • Set a trailing stop 2% behind the trade to lock in profits.  We'll talk trailing stops in later modules
  • Our stop/loss is placed just below support highlighted by trend lines
  • Risk Reward Ratio: Generally traders look for 2:1 or 3:1. We'll look at risk reward in later modules
In a down trend RSI tends to fluctuate between 10 and 60 with resistance levels between 50 and 60. Again, these ranges will change depending on timeframe, RSI period and the strength of the downtrend. I’ve charted the USD/CHF below showing the resistance level providing entry-level points of which there are 4 plus two touching 50.  To Trade this down trend traders will always follow the trend. Instead of entering at the 30 or 70 signal as they would in a range, the entry point will be as the RSI dips below 60 or 50. This really depends on how strong the trend is and what your trading strategy will be.  It also depends on your RSI settings, i.e. an RSI 5 will be more sensitive than an RSI 20, so the entry trigger will be higher.  In the below case I've highlighted short positions as the market dips below 50.

USD/CHF - How the RSI works in a Down Trend

RSI Indicator Divergence & Convergence 

The RSI divergence & convergence has similar trading properties to The MACD divergence & convergence, i.e. if theRSI is trending in the opposite direction to the price then this is an indication that there may be a price momentum reversal imminent. It's a trend reversal early warning system.  A Convergence is in many cases the forerunner to a bullish price momentum reversal, while a divergence is thought to be the forerunner to a bearish price momentum reversal. These moves tend to be more robust when they cross the overbought and sold line

Below in our RSI divergence chart of S&P 500 we have shown an example of a bearish divergence, where the price mechanism shows higher highs and RSI records lower peaks. These lower peaks in the RSI hints that weakening momentum in the upward price push is unfolding and that price may reverse. We can see this unfold below.  As this divergence is an early warning (leading indicator) a good entry point will be the next 70 line crossover after the divergence - Highlighted below.  

S&P 500 - RSI Negative (bearish) Divergence

RSI divergence indicators work best in ranging markets and can be traded as the "RSI Range Trade" in the "How it Works and Trading The RSI within a Range" section. However they can be used in trending markets.  Remember, always trade with the trend, so in an up trend many RSI divergences will signal a retracement (secondary trend), where traders can sell long positions (if this is part of their strategy). However, a full blown reversal may result after a divergence starting a new trend. Trade it as per "RSI Trend Trade" in the section "Trading The RSI in a Trend".  Be careful though.  The divergence doesn't always show a retracement or reversal.  In a strong up trend the price momentum may still go up.

bullish convergence happens when the RSI forms higher troughs while the price forms lower troughs.Again, this convergence is more robust when crossing the oversold indicator at 30.  This convergence suggests that downward price momentum is waning and a change in trend to the upside is possible.  Other indicators such as volume decreases, moving average convergence and support and resistance levels will also be useful in determining momentum shifts.

Trading the RSI  - Short-term Scenario

Day traders (Intra-day traders) and Swing traders (1 to 5 day horizon) can amend the RSI from 14 down to 2, 3, 4, 5 etc... When looking at RSI (2) overbought and oversold positions may only stay for up to an hour or a day, so it’s really only used for these short-term trades of 1 to 5 days. Since shorter period RSI’s are more volatile than longer period RSI's the overbought and oversold parameters must be changed away from 30 and 70.  For instance they may be moved to 5-10 for oversold and 90-95 for overbought. Each market and situation will have to tweak these parameters and some historical profiling will help set them as part of a trading strategy.

Below is how a Swing Trader may use the RSI
  • Analyse the longer trend using Moving averages, Peak trough analysis, support and resistance etc...
  • General rule - Trade with the trend
  • Drill into the market with a 15 minute chart
  • Use scanning packages to see where RSI is crossing signals
  • Set at RSI (5) on the chart.  Remember the RSI 5 is more sensitive than RSI 14
  • Buy trigger - Enter the trade long (buy) when RSI crosses above 30 or 40
  • Sell Trigger - Sell when RSI crosses above 70 or 80.  
  • Or buy, sell vice-versa if in a down trend
  • If there's major resistance prior to this trigger, then sell
  • A stop/loss is placed just below support or resistance highlighted by trend lines.  This could be no more than a 2% loss.
  • Risk Reward Ratio: Generally traders look for 2:1 or 3:1. We'll look at risk reward in later modules
This sequence will be a part of their over all trading set-up and strategy.

To Sum Up

The RSI is a standard component on any basic technical chart. The relative strength indicator focuses on the momentum underlying the security and is a great secondary measure to be used by traders. It is important to note that the RSI is often not used as the sole generation of buy-and-sell signals but used in conjunction with other indicators and chart patterns.

As we've seen, we can set the indicators price action sensitivity. The sensitivity of the indicator determines how quickly the trader enters the move and how accurate these trading signals are. If the indicator is set to low sensitivity then you generate less false signals, but you may see the move too late, or not see it at all. With high sensitivity you are more likely to catch the move into the trade, but you may generate false trading signals. For instance a swing trader (trading with a horizon of 4 to 5 days) may set the RSI to 3or 5 once they've drill down to an hourly chart from a daily chart. Good charting software will allow the parameters to be changed.

Technical analysis is not an exact science and although these indicators can increase the probability of making the correct trade, many will go against you and large losses can be incurred. Your own trading strategy needs to be formed and hopefully you'll be on your way to achieving this on completion of this course.

>>>>>>> c0fd65f8ac5b5830dc3df1d307fcababd602b3a9
Comments