Unorthodox RSI Trading Strategies
The Relative Strength Index (RSI) is a popular technical analysis tool that can be used in several unorthodox ways to determine the future movement of an asset.
Reminder: what is the RSI in trading?
The RSI is a momentum oscillator created by J Welles Wilder Jr and was published in his book New Concepts in Technical Trading Systems in 1978. The conventional use of the RSI indicator is to measure momentum and determine if prices are moving. are accelerated too quickly. Most traders use the RSI as a contrarian indicator, looking for turning points where an asset will change direction.
While using the RSI as an indicator of overbought or oversold can be useful, the three unconventional RSI strategies provided here can provide unprecedented trading opportunities.
Why modify the technical parameters of the indicator?
As you develop your trading style, you can consider different strategies to improve your success. Many traders use technical analysis to help them assess future movements in a security. Technical analysis is the study of past price movements to help you determine the future direction of an asset. (Although, of course, past performance is no guarantee of future results!) There are dozens of different technical indicators. Each uses a standard that the creator of the study likely published.
For example, when J Welles Wilder Jr released the RSI, he used 14 days as a benchmark. All of his analysis stems from using this time period to assess whether an asset has been overbought or oversold.
Fortunately, the markets are constantly changing. To keep pace and customize an indicator to suit your trading strategy, you should consider modifying an indicator to suit your needs. For example, if you are using a long term trading strategy, you might consider changing the period to 28 days or using weeks or months instead of days. If you are trading short, you can change the analysis period to ten days.
The standard RSI trading strategy
Technical analysis techniques allow you to see market trends as well as assess momentum. Momentum is the acceleration of the price of an asset.
The RSI is used to see how much an investment has accelerated over a specific time period. The index generates a number that oscillates between 1 and 100. The strategy described by Wilder uses the RSI to assess whether the price of a security is overbought or oversold.
An RSI reading below 30 is considered oversold. Readings above 70 are considered overbought. Conceptually, you would be looking for an opportunity to buy an investment when the RSI goes below 30.
Conversely, you would be looking to sell or sell an asset when the RSI posts a value above 70. You will find that the RSI can sometimes remain overbought or oversold for an extended period of time.
Yet there are also several unorthodox RSI strategies that can help you find different levels to enter a trading position.
A second way Wilder described using the RSI was finding periods of divergence. Divergence occurs when momentum is stalled, but prices continue to move in the direction of the trend.
A split between price and RSI can also occur when momentum is trending but prices are at a standstill. In each of these cases, the RSI tells you the rate of change relative to the price action, which can give you clues about the future direction of your investment.
Unorthodox RSI Trading Strategies
RSI-based trading strategies allow you to use momentum to determine the future direction of your investment. Three unconventional RSI strategies include positive and negative reversals, bullish and bearish ranges, and RSI trendlines. Each unorthodox strategy can be used in conjunction with other RSI trading techniques.
1. RSI crossover
When the RSI prints a reading that is either overbought or oversold, it does not give you specific indication that a reversal has occurred. If you are using the RSI to trade, you want a trading signal that can help you determine when to enter.
Cross signals are an unconventional way to create an RSI indicator trading strategy. You can also use the RSI to help you generate a signal.
For example, in the gold chart below, you can see the standard RSI of gold shown below the price of gold. A bullish or bearish signal occurs when the RSI returns above or below the signal range. When the RSI goes below 30 and then returns above 30, a reversal signal is created.
On the flip side, a sell signal is generated when the RSI goes above 70 and then drops back below 70. This strategy will tell you when the price breaks overbought or oversold territories and can help you avoid to enter a trade too early.
2. Change of RSI range
Wilder’s RSI analysis gives many ways to use the RSI for trading, but none are more important than the bullish and bearish ranges of the RSI. The ranges, which were created by Andrew Cardwell using Wilder’s standard RSI, reveal further insight into momentum.
The RSI generally remains static during uptrends versus downtrends. This is because the uptrends are generally smooth, like a staircase. Downward trends are usually marked, and many markets fall more than twice the rate of their ascent.
Since the RSI measures gains versus losses, the RSI will stay at higher levels during an uptrend. During a downtrend, the RSI will stay at lower levels.
Cardwell introduced RSI ranges to help determine where in the trend a market is trading. Ranges include positive and negative territory, overbought and oversold levels, and extreme overbought and oversold levels.
Under this strategy, bullish fields range from 50 to 70 but start near 40 and usually end near 80. Bearish levels range from 30 to 50 but can start near 60 and end at 20.
You can use Cardwell ranges along with other indicators to help you determine where you are in a trend cycle and the likelihood of the trend continuing in a specific direction.
For example, if you encounter a price breakout from the trendline and the RSI is near 70, according to this strategy, the trend could continue to rise as the RSI range is in bullish territory.
If the same scenario occurs at 80, the strategy suggests that the RSI is in extreme overbought territory and may not continue to rise. Cardwell also states that stocks have historically trended higher and therefore bullish levels can extend down to 40.
3. RSI trend lines
Another RSI based trading strategy that focuses on the unconventional use of the RSI is to draw trend lines on the RSI. Since RSI is a momentum oscillator, a trendline will help you determine the direction of momentum. You can draw a descending or an ascending trendline which, if broken, shows you that the momentum has reversed.
Note that drawing a trend line is somewhat subjective. One guideline you can use is to connect two or more points and extend the line to see the support and resistance levels.
You can also use trend lines to see if a market is diverging. Divergence occurs when momentum stagnates, but prices do not. If the RSI hits resistance and does not rise higher, but the price action increases, the momentum and price movements diverge, which could indicate that a trend is running out of steam.
You can see from the USD / JPY chart below that the breakouts and breakdown of the RSI coincide with the upside breakout and downside of the exchange rate.
Edited by Jekaterina Drozdovica
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