Brandon Wendell, CMT
Brandon Wendell
In my last article, “Relative to the Trend,” we discussed the use of the Relative Strength Indicator (RSI) as a way to help identify the trend and potential reversals of those trends. I mentioned that most traders and investors improperly use the RSI to receive buy or sell signals. Instead of using the indicator for entry signals, I use it more as a filter to keep me out of trades that are less likely to work.
The previous article specified the new parameters that should be used with the RSI. 60 is the new overbought and 40 is the new oversold reading. We use the RSI with those new parameters to help us determine whether we should enter a position or wait as price approaches supply and demand levels.
The RSI measures momentum in price movement. When we are moving in an uptrend, you would expect the momentum to be bullish and not become oversold at any time if the trend is to continue. An oversold reading means the bears have grown stronger and may reverse the price trend or not allow price to move upwards freely.
In an uptrend, we want to hold long positions as supply breaks and prices move to higher levels. If we see on pullbacks that the price fails to break 40 on the RSI, then you are still in a bullish trend and are likely to break the subsequent supply level.
In the following chart of SPY, when prices return to the demand zone the RSI is above 40. This suggests that the bullish trend is still intact. The location of the RSI above 40 confirms that there is still a lot of bullish pressure and that demand is likely to produce a significant price move upward and exceed the prior high.
However, if you are looking to buy during a pullback to demand and the RSI is below 40, you may want to pass on the trade or have a closer target since price is less likely to make new highs when/if it bounces.
In a downtrend, we want to let our shorts go as far as possible to maximize profits. Prices should not become overbought on the RSI while in a downtrend. Strong bullish pressure signals the downtrend is not as powerful as it was.
When we see rallies in the bearish trend fail to breach the 60 level on the RSI, then the bearish momentum and downtrend is still strong and we are likely to see prices continue to break demand levels.
If we see the RSI moving above 60 when price hits supply, we may want to look for another trade or have shorter targets as price is unlikely to make new lows if it does bounce from supply.
To remember the use of the RSI, I have come up with a saying: “If at demand and the RSI is less than 40, then demand will not stand. And if at supply and the RSI is above 60, then supply is a lie.
Remember that RSI, as with any technical indicator, is to be used as an odds enhancer. Educated traders know that the decision to buy or sell should be made from the price action itself and the use of the core strategy of Supply and Demand. To learn this valuable skill, visit your local Online Trading Academy center today!
Neither Freedom Management Partners nor any of its personnel are registered broker-dealers or investment advisers. I will mention that I consider certain securities or positions to be good candidates for the types of strategies we are discussing or illustrating. Because I consider the securities or positions appropriate to the discussion or for illustration purposes does not mean that I am telling you to trade the strategies or securities. Keep in mind that we are not providing you with recommendations or personalized advice about your trading activities. The information we are providing is not tailored to any individual. Any mention of a particular security is not a recommendation to buy, sell, or hold that or any other security or a suggestion that it is suitable for any specific person. Keep in mind that all trading involves a risk of loss, and this will always be the situation, regardless of whether we are discussing strategies that are intended to limit risk. Also, Freedom Management Partners’ personnel are not subject to trading restrictions. I and others at Freedom Management Partners could have a position in a security or initiate a position in a security at any time.
Editors’ Picks
EUR/USD holds steady above 1.1850 in quiet session
EUR/USD stays defensive but holds 1.1850 amid quiet markets in the European hours on Monday. The US Dollar is struggling for direction due to thin liquidity conditions as US markets are closed in observance of Presidents' Day holiday.
GBP/USD flat lines near 1.3650 ahead of UK and US data
GBP/USD kicks off a new week on a subdued note and oscillates in a narrow range near 1.3650 on Monday. The mixed fundamental backdrop warrants some caution for aggressive traders as the market focus now shifts to this week's important data releases from the UK and the US.
USD/JPY advances on weak Japanese GDP, holiday-thinned trading
USD/JPY rises while US and Japanese markets remain closed for holidays. Weak Japanese Gross Domestic Product figures curb tightening expectations. Investors await speeches from Federal Reserve Vice Chair for Supervision.
Editors’ Picks
EUR/USD holds steady above 1.1850 in quiet session
EUR/USD stays defensive but holds 1.1850 amid quiet markets in the European hours on Monday. The US Dollar is struggling for direction due to thin liquidity conditions as US markets are closed in observance of Presidents' Day holiday.
GBP/USD flat lines near 1.3650 ahead of UK and US data
GBP/USD kicks off a new week on a subdued note and oscillates in a narrow range near 1.3650 on Monday. The mixed fundamental backdrop warrants some caution for aggressive traders as the market focus now shifts to this week's important data releases from the UK and the US.
Gold sticks to intraday losses; lacks follow-through
Gold remains depressed through the early European session on Monday, though it has managed to rebound from the daily trough and currently trades around the $5,000 psychological mark. Moreover, a combination of supporting factors warrants some caution for aggressive bearish traders, and before positioning for deeper losses.
Bitcoin consolidates as on-chain data show mixed signals
Bitcoin price has consolidated between $65,700 and $72,000 over the past nine days, with no clear directional bias. US-listed spot ETFs recorded a $359.91 million weekly outflow, marking the fourth consecutive week of withdrawals.
The week ahead: Key inflation readings and why the AI trade could be overdone
It is likely to be a quiet start to the week, with US markets closed on Monday for Presidents Day. European markets are higher across the board and gold is clinging to the $5,000 level after the tamer than expected CPI report in the US reduced haven flows to precious metals.
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