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 hits two-day highs near 1.1820
EUR/USD picks up pace and reaches two-day tops around 1.1820 at the end of the week. The pair’s move higher comes on the back of renewed weakness in the US Dollar amid growing talk that the Fed could deliver an interest rate cut as early as March. On the docket, the flash US Consumer Sentiment improves to 57.3 in February.
GBP/USD reclaims 1.3600 and above
GBP/USD reverses two straight days of losses, surpassing the key 1.3600 yardstick on Friday. Cable’s rebound comes as the Greenback slips away from two-week highs in response to some profit-taking mood and speculation of Fed rate cuts. In addition, hawkish comments from the BoE’s Pill are also collaborating with the quid’s improvement.
USD/JPY drops back below 157.00, as focus shifts to Japan snap election
USD/JPY is back in the red below 157.00 in the Asian session on Friday. The Japanese Yen recovers ground against the US Dollar amid some profit-taking ahead of Japan's snap general election on Sunday. The preliminary reading of the Michigan Consumer Sentiment Index report for February will be released later on Friday.
Editors’ Picks
EUR/USD: US Dollar to remain pressured until uncertainty fog dissipates Premium
The EUR/USD pair lost additional ground in the first week of February, settling at around 1.1820. The reversal lost momentum after the pair peaked at 1.2082 in January, its highest since mid-2021.
Gold: Volatility persists in commodity space Premium
After losing more than 8% to end the previous week, Gold (XAU/USD) remained under heavy selling pressure on Monday and dropped toward $4,400. Although XAU/USD staged a decisive rebound afterward, it failed to stabilize above $5,000.
GBP/USD: Pound Sterling tests key support ahead of a big week Premium
The Pound Sterling (GBP) changed course against the US Dollar (USD), with GBP/USD giving up nearly 200 pips in a dramatic correction.
Bitcoin: The worst may be behind us
Bitcoin (BTC) price recovers slightly, trading at $65,000 at the time of writing on Friday, after reaching a low of $60,000 during the early Asian trading session. The Crypto King remained under pressure so far this week, posting three consecutive weeks of losses exceeding 30%.
Three scenarios for Japanese Yen ahead of snap election Premium
The latest polls point to a dominant win for the ruling bloc at the upcoming Japanese snap election. The larger Sanae Takaichi’s mandate, the more investors fear faster implementation of tax cuts and spending plans.
RECOMMENDED LESSONS
Making money in forex is easy if you know how the bankers trade!
I’m often mystified in my educational forex articles why so many traders struggle to make consistent money out of forex trading. The answer has more to do with what they don’t know than what they do know. After working in investment banks for 20 years many of which were as a Chief trader its second knowledge how to extract cash out of the market.
5 Forex News Events You Need To Know
In the fast moving world of currency markets where huge moves can seemingly come from nowhere, it is extremely important for new traders to learn about the various economic indicators and forex news events and releases that shape the markets. Indeed, quickly getting a handle on which data to look out for, what it means, and how to trade it can see new traders quickly become far more profitable and sets up the road to long term success.
Top 10 Chart Patterns Every Trader Should Know
Chart patterns are one of the most effective trading tools for a trader. They are pure price-action, and form on the basis of underlying buying and selling pressure. Chart patterns have a proven track-record, and traders use them to identify continuation or reversal signals, to open positions and identify price targets.
7 Ways to Avoid Forex Scams
The forex industry is recently seeing more and more scams. Here are 7 ways to avoid losing your money in such scams: Forex scams are becoming frequent. Michael Greenberg reports on luxurious expenses, including a submarine bought from the money taken from forex traders. Here’s another report of a forex fraud. So, how can we avoid falling in such forex scams?
What Are the 10 Fatal Mistakes Traders Make
Trading is exciting. Trading is hard. Trading is extremely hard. Some say that it takes more than 10,000 hours to master. Others believe that trading is the way to quick riches. They might be both wrong. What is important to know that no matter how experienced you are, mistakes will be part of the trading process.
The challenge: Timing the market and trader psychology
Successful trading often comes down to timing – entering and exiting trades at the right moments. Yet timing the market is notoriously difficult, largely because human psychology can derail even the best plans. Two powerful emotions in particular – fear and greed – tend to drive trading decisions off course.