RSI Demystified

Here I am... as promised. After the last post and the reference to RSI, it is but natural that I talk about RSI today. It was a close call as I also wanted to discuss few individual stocks which are getting interesting but then those have to wait for another time.

Some basics before we start; In technical analysis we have indicators and oscillators. Indicators are calculated based on the price, volume, momentum, volatility, etc. They give us additional information about the price and help us in technical analysis. Indicators which vary only in a range are called oscillators and Relative Strength Index (RSI) is one of them. It tells us about the strength or weakness in the trend of the security being analysed. It is calculated as;

RSI = 100 - 100 / (1 + RS)

Where RS = Average of x days' up closes / Average of x days' down closes

Usually RSI is calculated for a period of 14 days and it is the most popular duration. So for 14 days; RS = (Sum of Gains over last 14 days/14) / (Sum of Losses over last 14 days/14)

The formula above makes sure that RSI varies between 0 and 100. However, RSI does not practically go to 0 or 100 very often. We have seen RSI in many charts so I do not need to post one to explain more.

Most important use of RSI is to confirm the trend. If you think that the security is in an uptrend, be sure to confirm that RSI is above 50. Similarly RSI below 50 acts to help us confirm the downtrend for the security. However, main question is how do we use RSI for trading? There are various ways of doing so... some of them are;

• Overbought / Oversold conditions
• Divergences
• Positive / Negative Reversals
• Failure Swings
• Trending IDs

What we generally use is the first two. Rest of them do not occur often and are not so easy to spot. Overbought condition was already (more or less) explained in last post. Only thing to add here is it is universally accepted that RSI above 70 is overbought condition and below 30 is oversold condition.

Next, Divergence is used to identify the impending reversal in the trend of the security being analyzed. It usually happens when security makes a higher high (or higher low) but RSI fails to follow through. This is called as Bearish (negative) divergence - First rectangle in the chart below. Vice versa situation where security seems bearish but RSI is going up gives Bullish (positive) divergence and it usually signals things are about to turn positive.

My apologies for not coming up with a better graph which will give a clearer picture but I believe this one will also give the basic idea. Will not be talking about the balance 3 ways to trade RSI but will surely visit them if situation calls for.

I am happy that I was able to follow up yesterday's come back post with this small tutorial kind of post and hope that you will enjoy reading it as much as I enjoyed writing it. RSI is probably one of the most popular oscillator and it will continue to be part of our future discourse so this surely is just the beginning of it. Will think about the third post tomorrow and decide whether to write another tutorial or post some stocks specific charts. If you have any ideas, I am all ears.

 Stay tuned for my (probably) first hat-trick tomorrow. Happy Trading.

RSI Scare

First of all, my most sincere apologies to all of you. Though I wish to... but there is no gain if I spend more time in explaining my absence. I know you are not interested in knowing those reasons behind my absence and would simply want me to get back to writing trading and tutorial posts. So will not bother you more and  get to that straight away.

I had explained some of the scenarios and their meaning in my last post which was two weeks back. Since then we have had two positive weeks and things are extremely interesting now.

We have created a new peak in last two weeks. Also we have managed three higher lows now on weekly basis. To be honest, I was not expecting the rise in last two weeks. I would have settled for rise of the first week and would have bet against the second week but then such are the markets. This week, I am definitely betting against the similar rise though we may not fall much.

MACD is flat but RSI is nearing the overbought zone as seen above. RSI is much more overbought in daily chart. Have a look below on daily chart. Also worth noting is that RSI in overbought or oversold zone has been very reliable in last two years or so and I have marked instances of RSI overshooting the upper band and subsequent market reaction.

Presently also, as seen above, RSI is in stratosphere and that certainly is not a good sign in short term. Expect some weakness in the NIFTY this week but do not short heavily. Things often get irrational in a strongly trending market in either direction. Otherwise how would you explain last two weeks with virtually no change in fundamentals of companies, Country or World.

Then I cannot help but share good news that I have been promoted after successful completion of my last project. This development in partially responsible for my absence. However after thinking a lot about best way to apologize and make amends with all my readers, I have decided to write three posts on the trot in three days. That was the only thing which came to my mind and hope you would like it too. So I am going to go all out of my way to make sure that you have two more posts in next two days. Will also be back on Twitter in case you want those supports and resistance levels.

Needless to say, will love to hear your comments. Happy Trading.

Watta Week

A lot has happened since I made last post a week back.

There was power outages which crippled almost 600 Million people in a rising superpower country. There were blasts in my home town, Pune, in an area which can be very crowded on the eve of Rakshabandhan. There has been RBI meet in last week with only symbolic action coming through. There was a Fed meeting too not very different from RBI. Then we now officially have a drought which further threatens our already paralyzed economy. We have managed a few medals (way less than whats Phelps alone have won) in Olympics.

Let us hope this week brings us some real good news.

I have been trying to write a post every 2-3 days but things have been not working out as well so I will have to manage with what best I can do. Let us see what charts tell us for coming week.

See the weekly chart for NIFTY above. The upward pointing arrows indicate higher highs that we are getting from Jan. If we had got higher highs also, that would have meant some thing but the high of June last week was lower than the Feb and that is where this theory is weakened. Right now also, the coming week is very important and a positive week will give us at least some hope that uptrend is not ruled out completely. However a negative week will leave open the possibility that low of 2 weeks back was not the final low and we may go on to make a low which is lower than the low of June first week. This will almost completely negate the possibility of uptrend.

My reading; we are not out of the woods as yet. At the same time I am also getting a 'feeling' that we may be at the end of this long term bear correction. Usually such long term trends end in high power euphoria (bull) or high despair carnage (bears) which is yet to be seen. That is the reason I don't think we have seen the end of this downtrend. What are we waiting for? May be some kind of shock after all.

Europe, US or even China can bring about that kind of shock which can kill the sentiments and make everyone lose hope. That precisely will be the point to start investing and make merry. If we don't get such bad news from outside, may be we can make Pranab Da FM again. That will certainly qualify.

Will have to make another post soon. It is already half made and won't be long.

Happy Trading. Don't forget the comments.