RSI Fluctuations to Confirm Trends

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The RSI, or Relative Strength Index, is a popular technical indicator, and has many different uses. By looking at the range the RSI is fluctuating in, it is often possible to tell whether a price trend is likely to continue, or if it is reversing.

The RSI falls into a family of indicators called “oscillators.” The indicator moves back and forth between 100 and 0 (rarely reaching those extremes) as the price moves up and down.

As figure 1 shows, the RSI is highly correlated to the price, rising and falling as price does. The RSI will fluctuate to varying degrees though, since it is always comparing the magnitude of recent price gains to recent price losses and then converting it into a number between 100 and 0.

Figure 1. Apple (AAPL) stock with RSI Indicator

The levels that the RSI fluctuates between, let’s call it the RSI range, can help determine and confirm the trend.

During an uptrend the RSI will almost always have peaks above 80–often 90 in a strong trend–and will create lows above 30. Levels may vary slightly between individual stocks, or across markets, but these are a good general guideline.

As figure 2 shows, during the uptrend, the RSI continually reaches peaks of 80 or higher, and holds the 30 area on lows (pullbacks in price).

Figure 2. S&P 500 SPDR (SPY) with RSI Uptrend Range

Seeing the RSI continually reach the 80 region provides confirming evidence that the uptrend is still strong.

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The RSI holding above 30 also provides confirming evidence. The indicator is not perfect though. We can see on a number of occasions the price dipped slightly below the 30 level even though the overall trend remained up.

During a downtrend the RSI will generally touch 20 or below–reaching to 10 on strong downtrend moves–and create highs below 70 (60 in some markets).

Figure 3. Apple (AAPL) stock With RSI Downtrend Range

Throughout the downtrend Apple isn’t able to claw much above 70, and continually reaches lows of 20 or lower. These factors help confirm the downtrend.

At the far right of the chart, there is a green arrow on the RSI. It marks a point where the RSI extends well above the downtrend RSI range, reaching 91. This generally doesn’t happen during a downtrend, so it is a warning sign that the trend may be reversing, or the price is entering a sideways phase.

That green arrow, and the associated move higher, occurred just after the start of May 2020. If you look back to figure 1, that point was the beginning of the uptrend shown on that chart.

“Wilder’s RSI” uses a slightly different calculation, and seems to work a bit better at confirming trends using the above method. Since not all charting platforms have Wilder’s RSI, the standard RSI has been used for the above examples. When possible, use Wilder’s RSI.

Bring it Together

RSI ranges are a tool, but are not infallible. While the uptrend and downtrend ranges can confirm trends and warn of reversals, it is always advised that price analysis is done as well. For example, in an uptrend if the RSI dips a little below 30 but the price is still making higher-highs and higher-lows, then trust the price action. Ultimately price is what makes us money, and indicators just help us interpret price moves.

Levels may vary by individual stock, forex pair or other instrument, therefore, establish the appropriate ranges for the instrument you are trading using historical data. This will provide you a baseline to work from. If you like this method, come up with some personal guidelines on how to use it and incorporate it into your trading plan.

Trend Trading: The 4 Most Common Indicators

Trend traders attempt to isolate and extract profit from trends. There are multiple ways to do this. Of course, no single indicator will punch your ticket to market riches, as trading involves factors such as risk management and trading psychology as well. But certain indicators have stood the test of time and remain popular among trend traders.

In this article, we provide general guidelines and prospective strategies for each of the four common indicators. Use these or tweak them to create your own personal strategy.

Moving Averages

Moving averages “smooth” price data by creating a single flowing line. The line represents the average price over a period of time. Which moving average the trader decides to use is determined by the time frame in which he or she trades. For investors and long-term trend followers, the 200-day, 100-day, and 50-day simple moving average are popular choices.

There are several ways to utilize the moving average. The first is to look at the angle of the moving average. If it is mostly moving horizontally for an extended amount of time, then the price isn’t trending, it is ranging. If the moving average line is angled up, an uptrend is underway. Moving averages don’t predict though; they simply show what the price is doing, on average, over a period of time.

Crossovers are another way to utilize moving averages. By plotting a 200-day and 50-day moving average on your chart, a buy signal occurs when the 50-day crosses above the 200-day. A sell signal occurs when the 50-day drops below the 200-day.   The time frames can be altered to suit your individual trading time frame.

When the price crosses above a moving average, it can also be used as a buy signal, and when the price crosses below a moving average, it can be used as a sell signal. Since the price is more volatile than the moving average, this method is prone to more false signals, as the chart above shows.

Moving averages can also provide support or resistance to the price.   The chart below shows a 100-day moving average acting as support (i.e., price bounces off of it).

MACD (Moving Average Convergence Divergence)

The MACD is an oscillating indicator, fluctuating above and below zero. It is both a trend-following and momentum indicator.

One basic MACD strategy is to look at which side of zero the MACD lines are on in the histogram below the chart. Above zero for a sustained period of time, and the trend is likely up; below zero for a sustained period of time, and the trend is likely down.   Potential buy signals occur when the MACD moves above zero, and potential sell signals when it crosses below zero.

Signal line crossovers provide additional buy and sell signals. A MACD has two lines—a fast line and a slow line. A buy signal occurs when the fast line crosses through and above the slow line. A sell signal occurs when the fast line crosses through and below the slow line.

RSI (Relative Strength Index)

The RSI is another oscillator, but because its movement is contained between zero and 100, it provides some different information than the MACD.

One way to interpret the RSI is by viewing the price as “overbought”—and due for a correction—when the indicator in the histogram is above 70, and viewing the price as oversold—and due for a bounce—when the indicator is below 30.   In a strong uptrend, the price will often reach 70 and beyond for sustained periods, and downtrends can stay at 30 or below for a long time. While general overbought and oversold levels can be accurate occasionally, they may not provide the most timely signals for trend traders.

An alternative is to buy near oversold conditions when the trend is up and place a short trade near an overbought condition in a downtrend.

Say the long-term trend of a stock is up. A buy signal occurs when the RSI moves below 50 and then back above it. Essentially, this means a pullback in price has occurred, and the trader is buying once the pullback appears to have ended (according to the RSI) and the trend is resuming. The 50 levels are used because the RSI doesn’t typically reach 30 in an uptrend unless a potential reversal is underway. A short-trade signal occurs when the trend is down and the RSI moves above 50 and then back below it.

Trendlines or a moving average can help establish the trend direction and in which direction to take trade signals.

On-Balance Volume (OBV)

Volume itself is a valuable indicator, and OBV takes a lot of volume information and compiles it into a single one-line indicator. The indicator measures cumulative buying/selling pressure by adding the volume on up days and subtracting volume on down days.

Ideally, the volume should confirm trends. A rising price should be accompanied by a rising OBV; a falling price should be accompanied by a falling OBV.

The figure below shows the shares of Netflix Inc. (NFLX) trending higher along with OBV. Since OBV didn’t drop below its trendline, it was a good indication that the price was likely to continue trending higher after the pullbacks.

If OBV is rising and the price isn’t, price is likely to follow the OBV and start rising. If the price is rising and OBV is flat-lining or falling, the price may be near a top. If the price is falling and OBV is flat-lining or rising, the price could be nearing a bottom.

The Bottom Line

Indicators can simplify price information, as well as provide trend trade signals or warn of reversals. Indicators can be used on all time frames, and have variables that can be adjusted to suit each trader’s specific preferences. Combine indicator strategies, or come up with your own guidelines, so entry and exit criteria are clearly established for trades. Each indicator can be used in more ways than outlined. If you like an indicator, research it further, and most importantly, test it out before using it to make live trades.

Learning to trade on indicators can be a tricky process. For those who have yet to enter the market or start trading, it’s important to know that a brokerage account is a necessary first step at getting access to the stock market.

How do experienced traders identify false signals in the market?

Experienced traders often use multiple technical indicators and theories for market analysis to develop trading strategies. The key element of technical analysis is the identification of signals. Sometimes, due to timing lags, data corruption or smoothing methods applied to certain indicators can cause these false signals. To identify false signals and avoid trading on them, experienced traders try to eliminate as much noise from the market data as possible.

Removing noise from a chart helps traders better identify true elements of a trend. One way traders do this is by averaging candlesticks on a chart. Using only the averages eliminates the intraday fluctuations and short-lived trend changes, creating a clearer image of the overall trend. Other charting methods seek to display only actual trend-changing moves, ignoring all other price data. One such chart is the Renko chart, which accounts for price changes but not time or volume. Canceling all noise, in this case, time, can make applying other indicators for confirmation difficult.

A better noise-canceling charting method is the Heikin-Ashi chart; it turns simple candlestick charts into those with easy-to-spot trends and changes. Since it still incorporates time, other indicators such as the directional movement index, or DMI, and relative strength index, or RSI, can be applied. By using multiple indicators and charts that cancel out noise, traders more effectively spot true signals. When a trader applies multiple indicators to a standard chart and receives one signal from an indicator while the others do not give a signal, the trader can confirm the false identity of the signal by looking to a noise-canceling chart.

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