Trendlines and RSI

RSI or Relative Strength Index is an oscillator and is constructed by measuring a stock or index' gains against their losses. So if the range of its gains is greater than its losses the oscillator would rise, conversely if the range of its losses were greater the oscillator would fall. Like Moving Averages the oscillator needs a time period offset to measure this activity. The normal default number used by many technicians is 14 although I have also seen and used 20.

The oscillator just like a stock moves up and down in value. The oscillator only has a range of 1 -100 and it is within the confines of this range that it attempts to define what an overbought or oversold condition is in a stock or market. Most programs or analysts follow it using the default below 30 as oversold and above 70 as overbought. This range of under 30 to over 70 does not mean that a stock will not continue to sell down or continue to move up once it hits these ranges. The oscillator can remain below 30 or above 70 for weeks or months depending on which chart you are looking at. There are some who watch for the RSI to pass 50 as an indication that price is trending more dynamically in one direction or the other.

There are many times when the oscillator will not reach 30 during a correction and not reach 70 during an uptrend. We use this indicator as a way of gauging the relative strength of price now to price previous. Those investors that use charts to gauge the significance of price activity want to know if price is strengthening or weakening. It is in this manner that we can help visually to determine if a stock is trending up significantly or downwards in a fashion that will allow us to trade it profitably. Charts are a must if you are an investor/speculator. Without charts and indicators one has no way of knowing whether a stock or market is building strength or becoming weaker.

The RSI can be used in conjunction with other indicators to time the market and gain a, more, well rounded view of trading activity.

The RSI oscillator is also subject to interpretation when viewed through a different, figurative, lens filter. Since the oscillator is subject to movement up and down that activity can be measured or gauged against other activity that has taken place prior to it. Perhaps the most well known measure of this activity is called divergence.

Divergence occurs when an oscillator either rises more than or less than it did previously at a same or similar price. This occurrence can also be measured when the oscillator is significantly higher or lower at a current high or low price than at a previous high or low price. Highs and highs and lows and lows can be measured against one another this way. There are other significant nuances to divergence we will not go into in this article but suffice it to say, for now, it can be very important in gauging relative market strength or weakness. Divergence is frequently used to time the market to determine if an uptrend is beginning to fade or if a sell off has lost steam and is getting ready to reverse. Divergence should also be used in conjunction with other tools to more accurately time when this becomes of greater importance.

Trendlines can help to time this activity, with greater precision. As the oscillator begins to rise, or fall,. we watch for pivot points (please see more on pivot points in our article Trendlines and Pivot Points) that have trendlines intersecting them. These trendlines, inevitably, are crossed by price during a reversal or continuation of trend. It is during this crossing that we must watch the oscillator's activity and gauge whether it is in a strong position or a weak position and is the break of the trendline supporting the direction of the oscillator. If the oscillator and trendline both support the direction and magnitude of the move then we have a greater opportunity to profit from a trade.

This is actually a fairly simple relationship to distinguish but it takes time to appreciate its value which can only be done through observation and patience.