Number 6
Please
note that we have used historical data. These
examples are for educational purposes only.
The
Relative Strength Index (RSI)
This
month we'll focus on one of the most commonly
used indicators; the Relative Strength Index.
This indicator was developed by Welles Wilder
Jr. as a momentum oscillator, to take into consideration
some of the weaknesses of other oscillators
and to make it more responsive to the velocity
of price movements. The term "Relative Strength"
is slightly misleading and often causes some
confusion. Relative strength generally means
a comparison between two different markets or
indices. RSI, on the other hand, looks at the
internal strength of one particular market,
measuring the relative changes between the higher
and lower closing prices I'm also going to introduce
some of the more advanced interpretations of
RSI, drawn largely from the work of Constance
Brown in her book, Technical Analysis for the
Trading Professional.
CURRENT
TRENDS - Learning from the Dow Jones Industrials
The
RSI indicator is traditionally used as an overbought
and oversold indicator, like most of the oscillators
such as Stochastics, ROC, CCI, etc. This means
looking for extreme highs and lows in the indicator;
when the RSI forms an extreme high at 70-80
this is taken to mean an overbought condition,
and a signal to consider selling. Conversely,
an RSI forming an extreme low at 20-30 is considered
an oversold condition and the time to consider
buying. These signals have proven useful in
the past... but there's more. Let's look at
the DJIA to see what's happening with current
markets using the RSI indicator.
Here's
a weekly price chart showing the current DJIA,
offering us a long-term look at market trends.
As usual, I've drawn a series of trend lines
to make the trends more apparent.
We are
obviously still in a primarily uptrending market,
however a sideways market in the shape of a
diamond has unfolded over the past 16 months.
This is considered a significant pattern by
many analysts, with the right half representing
a symmetrical triangle, marking a period of
congestion in the market often preceding a pronounced
move in one direction or the other.
When
we look at the RSI chart, we can see that it
has offered several good signals in the traditional
sense of overbought/oversold markets (red arrows
signalling overbought and green arrows signalling
oversold conditions).
Another
interesting observation is based on the two
sets of lines I've drawn, marked as the "Bull
Market Range" (in red) and the "Bear Market
Range" (in blue). This interpretation is based
on the fact that RSI tends to stay in a band
between 40 and 80 when the market is bullish,
and it tends to stay in a band between 30 and
65 when it is bearish. In general we can see
that this is true. Since July 99 the RSI has
stayed in the "Bearish Range" and at the beginning
of this year it tested the top of the range
at 65, but failed to break above the line.
Finally,
the blue trend line I've drawn on the RSI chart
shows that the RSI has been in a downtrend since
May 1999.
My conclusion?
As long as the RSI stays within the Bearish
Range, we will continue to see a weak DJIA.
Watch for the traditional signals: divergence
between the price and RSI, an extreme low or
high in RSI (showing overbought or oversold
conditions), and a break in the current trendline
for RSI. Also watch for a move above 70, indicating
a possible break out of the current Bear Market
Range.
TIPS
& TECHNIQUES - Using the Relative Strength Index
Here's
what Welles Wilder has to say about using RSI:
"One
of the most useful tools employed by many technicians
is the momentum oscillator. The momentum oscillator
measures the velocity of directional price movement.
When the price moves up very rapidly, at some
point it is considered overbought; when it moves
down very rapidly, at some point it is considered
to be oversold. In either case, a reaction or
reversal is imminent. The slope of the momentum
oscillator is directly proportional to the velocity
of the move. The distance travelled up or down
by the momentum oscillator is proportional to
the magnitude of the move."
Wilder
indicates five factors in interpreting RSI alongside
price:
- Tops and
bottoms: When RSI goes above 70 or below
30. RSI usually tops out or bottoms out
before the actual market, giving an indication
of imminent reversal, or at least reaction.
- Chart formations:
Patterns, including tops or bottoms, triangles
and trendline breaks.
- Failure swings:
when the RSI goes above 70 or below 30 but
fails to exceed the previous high or low.
- Support and
Resistance: support levels in RSI are
often analogous to those on the price chart.
- Divergence:
divergence between price action and the
RSI is a very strong indicator of market
turning points.
For
detailed information see the report on RSI
at ChartFilter.com.
PROFIT
POTENTIAL - Research in Motion Inc (RIM)
RIM
Shares Top Nasdaq Gainers on Strong Q3 Revenues
11:34 EDT Friday, September 29, 2000
TORONTO
(Reuters) - Shares in Research In Motion sprinted
out of the gate on Friday morning after the
maker of the popular Blackberry two-way wireless
pager demonstrated its costly marketing programs
are reaping rewards.
RIM
said after the markets closed on Thursday that
its revenues in the second quarter rose 57 percent
from the first quarter to $42.5 million. Analysts'
estimates had ranged between $33 million and
$36 million.
The
news certainly looks good for RIM. Is there
anything that RSI can tell us about this market?
Read on...
RSI
is currently supporting the bullish scenario
for RIM. It did issue an overbought warning
in early September, however, which shouldn't
be discounted altogether. The other cautionary
note is regarding the most recent trend line
in RSI (shown in pink). If this trendline continues
to hold, it indicates a divergence from the
price, offering a warning that RIM could lose
steam very quickly. Compare this peak with the
RSI pattern from February and March.
Keep
your eye on RSI:
- If RSI makes
a new peak above 70 you have a second overbought
warning.
- Similarly, If
RSI falls below 40 it could be signalling
a loss of momentum for RIM.
- As long as RSI
continues to meander along in the channel
between 40 and 80, however, the bullish
scenario is likely to be maintained.
Putting
ChartFilter into Context
ChartFilter
is meant to complement your overall trading
knowledge and decision-making. This newsletter
focuses on applying technical analysis (TA)
methods to various markets; but this is not
to say that you shouldn't be considering important
fundamental criteria, such as EPS or revenue,
as well. Think of ChartFilter as your TA assistant;
not as your overall trading strategist.
