In this instalment of our educational series, Indicator Insights, we shift our focus to the Relative Strength Index (RSI), exploring a non-traditional approach that harnesses its power to identify strong momentum stocks.
While the conventional use of RSI is often associated with overbought and oversold conditions, our alternative method employs RSI as a relative strength indicator, uncovering stocks exhibiting high levels of relative strength.
Understanding RSI - The Traditional Approach
The RSI is a momentum oscillator that measures the speed and change of price movements. Traditionally, traders use RSI to identify overbought and oversold conditions. The standard interpretation suggests that a stock is potentially overbought when the RSI surpasses 70, indicating a potential reversal or pullback. Conversely, an RSI below 30 might suggest that a stock is oversold, hinting at a possible upward reversal.
A Different Perspective - RSI as a Relative Strength Indicator
Our alternative approach views RSI as more than just an overbought/oversold signal generator. Instead, we leverage it as a relative strength indicator, pinpointing stocks that exhibit robust momentum compared to the broader market. The strategy involves waiting for an RSI reading to reach +75, signalling significant strength, and then strategically entering a position during a pullback when the RSI retreats to 50.
Waiting for the Pullback (RSI 50): Exercise patience and wait for the RSI to retreat to 50. This pullback suggests a temporary cooling-off period in the stock's momentum.
Strategic Entry: Initiate a long position when the RSI starts to move back above 50, anticipating a potential resumption of the strong upward trend.
Advantages of This Approach:
Relative Strength Focus: By emphasising relative strength, this strategy aims to align with stocks demonstrating a sustained and potent upward trend compared to the broader market.
Disciplined Entry: Waiting for the RSI to retreat to 50 provides a disciplined entry point, reducing the likelihood of entering trades during extended periods of overbought conditions.
Momentum Confirmation: Combining RSI readings with a pullback strategy helps confirm the sustainability of the stock's momentum before entering a position.
Potential Limitations:
False Signals: As with any strategy, false signals may occur, especially in volatile markets. Traders should exercise caution and consider additional factors in their decision-making process.
Market Conditions: This method may perform better in trending markets and may be less effective in choppy or sideways conditions.
Worked Example 1: Buying RSI Pullback on Daily Timeframe
Let's illustrate this approach with a practical example:
Pullback to RSI 50: Tesco experiences a pullback, and RSI retreats to 50.
Strategic Entry: A long position is initiated as the stock shows signs of resuming its strong upward trend and RSI turns back above 50.
Tesco (TSCO) Daily Candle Chart Past performance is not a reliable indicator of future results
Worked Example 2: Buying RSI Pullback on Hourly Timeframe
Stock: Apple (AAPL)
RSI Reaches +75: Hourly RSI for Apple reaches +75, signalling strong momentum.
Pullback to RSI 50: Apple experiences a pullback, and RSI retreats to 50.
Strategic Entry: A long position is initiated as the stock shows signs of resuming its strong upward trend and RSI moves back above 50.
AAPL Hourly Candle Chart Past performance is not a reliable indicator of future results
Summary:
This non-traditional use of RSI as a relative strength indicator offers traders a simple way of identifying and capitalising on strong momentum stocks. By waiting for RSI to reach +75 and strategically entering during a pullback to 50, traders can align with stocks exhibiting exceptional strength relative to the broader market.
Disclaimer: This is for information and learning purposes only and is intended for UK audiences. The information provided does not constitute investment advice nor take into account the individual financial circumstances or objectives of any investor. Any information that may be provided relating to past performance is not a reliable indicator of future results or performance. Social media channels are not relevant for UK residents.
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apdusp
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RSI is really a powerful and flexible tool. I found very interesting, out of looking at levels in RSI, the crossing between RSI9 and RSI14 as well as checking RSI2 for short term extremes. I use this in combination with SlowStoch(8,3) and TRIX(8,1)
bimef
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I am really grateful for this write up. It really impact more knowledge about the RSI and now I understand better. Thumbs up
DemoDiaryFX_Trading
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thanks for your work, and do you personally trade with this strategy? What results you have?
TradingView
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Good one on getting reviewed for an Editors Pick. Thanks for sharing your idea with the community.
Welles Wilder & his Student that is (My Mentor) is Such Genius.
RSI is the only indicator that is smoother and more reliable than any indicator out there if you use Properly.