Today's' lesson has a very nice illustration that has set up on the eur/usd, so that is the chart you will see above (1H time frame). We will be discussing the Relative Strength Indicator (RSI).
The RSI was developed as a tool to measure the strength of any move, whether long or short, and it's likelihood to continue. It is also a forward looking tool, as if used correctly makes for a decent forecasting indicator. Most of you will recognize the value in that, as most all other indicators are lagging, and provide very little help in the way of forecasting.
On our chart above, the RSI is the to of the three indicators you will find at the bottom of the chart. The settings I use for the RSI are 3 periods, applied to the close, with the indicator itself showing levels of 30, 50 and 70. All of these are adjustable in your MT4 charts.
So let's talk first about the indicator itself. Generally, as prices are rising, the indicator will rise also, thus revealing strength in a rising, or bull, trend. The inverse is true for falling prices. So at first glance, it seems to not show anything more than the price action itself. So what kind of good would that be? But let's take a deeper look.
In today's chart you can see a swing high in the price action at around 1.1990. If you look at the RSI, you can actually see two little peaks corresponding with that rise. As the second peak on the RSI is really no higher than the first one, we see a divergence in the indicator. Because the price continued higher, but the indicator did not. this is the first "evidence" of weakness in the rally. Higher highs in the price should be met with corresponding higher highs in the indicator.
Also, you can see the red line I have drawn on the chart in the price frame, showing the support level for the euro. In the RSI frame underneath, you can see a similar support line on the indicator. Here is the forecasting value of the RSI. When a trend is weakening, the indicator will often weaken before the price action. Many traders use that a signal to sell...once the RSI has crossed below it's support level. In such a case, you would simply place your stop above the most recent swing high.
Other traders will wait to see the a second validation, and that is the RSI crossing below the 50 level. This signals that the move has turned bearish. As the move continues, (which this chart does not show), traders watch the RSI on subsequent rebounds, to see if the indicator stays below 50. If so, then the trend is still intact. Above 50 becomes questionable. Moves that continue on below the 30 level are considered very bearish.
For a bullish just revers the above information, and everything above 70 is considered very bullish.
In our chart, you can see that the last hour posted a strong rebound, closing well off of its low. The RSI remains below 50 and is pointed downward indicating a continuation. But as we watched the RSI cross the support line around 1.1960, and the impulse move continued down to 1.1916, that would have been a great move all by itself, even if it is reversing now. Following the price with a trailing stop would have you out with 20 or so pips, or simply keeping your stop at the recent swing and then moving it down as the price makes a new swing low, will also keep you in. If it turns into a longer term move, you may gain more pips this using the latter method.
Now some of you may be wondering why i didn't recommend this trade in today's alert. Here's why. For a short term trade, this is a very nice set up. But for the longer term trades wea re looking to make, I';d prefer to see a rise tot he Fibonacci resistance that you see marked in yellow. A rise to the line marked 61.8, with a stalling action in the price and then a cross of the RSI would be very nice. But i'd consider it a much safer entry to come in at that level, rather than on a weaker entry such as has been exhibited.
Remember, we want to cherry pick our trades from the very best set-ups, and not take ones that are marginal. And even if this turns into a big move down, it does not change the fact that the entry, and thus the prospects for the trade, are only marginal, rather than optimal. We'll watch to see how this unfolds, and comment on it tomorrow.
Happy Trading!
Bill
No comments:
Post a Comment