Relative Strength Index (RSI) – A Trend Following/ Confirmation Tool

We have touched upon the basics in our previous 2 chapters in ours break down of RSI applications. The signal of overbought and oversold based on 30 and 70 are weak but can be enhanced but a divergence setup. Even this can extend further. Perhaps we should look at other approaches of using the RSI, namely the opposite.

Instead of monitoring the RSI as a range trading tool, why not look at it as a trend following tool. If the market shows abundant examples of trend continuing after a show of OB/OS signal maybe we should examine the trend following applications.

There are 2 advanced signals that they don’t teach in the basics of RSI. I first encountered these techniques in the “Technical Analysis for the Trading Professional” by Constance Brown CMT. She credits much of her knowledge to Andrew Cardwell who is a modern day guru of this technical indicator.

We had previously mentioned that when you think about when the RSI is above 70, showing overbought conditions, it is also showing bullish momentum, so in the right context, it it a bullish signal. (The right context meaning basically that it is not always going to be a bullish signal.) However, if you witness multiple failures, and then a quick attempt, it is sometimes considered a “pop”. The RSI pop is something we can investigate closer, but the point is that the overbought condition sometimes suggest only a temporary pause, but signals further intent.

There are another 2 signals that help confirm the trend.

1) A healthy bullish trend should be confirmed by the 14-period RSI staying above the 40 level. Vice versa, a healthy bearish trend should keep the RSI below 60.

2) After a bullish trend is established, a positive reversal signal occurs when the RSI makes a lower low, but the corresponding price low does not. This suggests another swing and we can use a swing projection.

Further details of the two trend confirming/following applications are discussed in the video below. Enjoy, and make sure to test out this method over many different pairs and during different time-frame. See if these approaches make sense to you, and see if you can integrate them in your trading plan.

Previous RSI chapters:
Introduction and a Basic Misconception
RSI – Bullish and Bearish Divergences

Next:
Ichimoku Basics