RSI indicator strategy, Part 2

This RSI Indicator Strategy video may be considered heretical. But it hey, if it makes money, then that’s what really matters. Try it out and prove it to yourself. This video is part 2 of a 3 part series on the RSI indicator strategy. Click Here for part 1.

What most teachers, books and courses instruct about how to trade the RSI indicator, is exactly the opposite of what you should be doing.

This is part 1 of 3 videos demonstrating how to correctly trade the RSI.

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VIDEO TEXT:

There will be 3 parts of this video, so look for part 3 of the RSI indicator strategy that will pick up where this one left off.

Welcome to this video on the RSI Indicator Strategy Part 2. If you didn’t see part 1, well go ahead and watch this video now you’re here, then go back and watch part 1.

We’re going to share a couple of extra things. You notice that my RSI Indicator looks a little different now. And let me point out to you what we’ve got.

SETTING UP THE RSI INDICATOR

The blue line here, that’s the RSI Indicator. And as I talked about before, its range bound. It can only go from 0 to 100. And so I put some extra lines on here. There is your mid line that’s 50. These are considered what we call the oversold line at 30, overbought line at 70 which I said are not good terms. And that’s what we talk about in part 1, so go and read that, or listen to that.

The other line to put on here are at 60 and at 40. These are very significant. So this is a different way to read RSI indicator strategy. Many people just look for these overbought, oversold signals and are doing them backwards. Whereas actually going up here shows strength. Once we start getting into the bullish territory, which would we above 50, then we are looking at a relative strength. Now remember that’s what this is, RSI. Relative Strength.

Once we get above there, and especially if we got to 30. But we are into bullish territory now where we get above 60. So not going to make it go all the way to 70 but above 60. So once we get above 60, then we are going to look at 40 as a support level. And as long as we can stay above 40 in a bullish trend, we’re going to consider that bullish momentum or strength. A strong trend. And again the RSI is a blue line. It’s a very choppy line, its one thing I don’t care about.

THEY’RE TEACHING THE RSI INDICATOR STRATEGY 180 DEGREES WRONG!

We don’t want it to be all the way down to 30 because otherwise that actually indicates strength to the downside, contrary to what most people think that it’s oversold. No. that would actually be strong bearish signal. But we do want it to stay above 40. And if it stays above 50, well even better. And so this whole time, you can see big move up and the RSI does stay above 40 and even mostly above 50. So that is another better way to read this.

Trading it in the direction of the trend is one of the keys. One of the biggest mistakes people do is they try to always use these oscillators. Especially these bounded oscillators to trade against the trend and that’s just disastrous. you use momentum or strength indicators to indicate the strength of trading with the trend, not for a reversal trade.

Here’s a situation where the RSI basically is just staying between our 40 and 60 line. And so it’s hovering around 50. And what happens during that, consider that our neutral zone. It’s not showing strength to the upside, or the downside. We want to show strength to the upside or the downside first. And as long as we are in that neutral zone, the market doesn’t really go anywhere.

Because there’s no strength or rate of change, great rate of change going to the upside or the low side. That whole area, as long as we get stuck in there, not just retracing to it, but when we get stuck in there, then I consider that just a neutral zone and that’s one way to help avoid getting into choppy markets. That’s a question I get often as, ‘Barry how to stay out of choppy markets?’ Well that’s one technique you can use right there.

MAKING RSI INDICATOR SIGNALS MORE CLEAR

Now in this shot, what I’ve done is I’ve added a moving average to the RSI indicator strategy. So this is a 9 period moving average, the black line of the RSI Indicator. So all that does is smooth it out a little bit, and because it is a moving average, it will be a little lagging. But it doesn’t create all of these jagged lines. That’s option if you want it or not. You don’t have to use that. But again, you’ll see the signals watching those different horizontal lines as to where it is.

Now one of the keys here is that you can actually use momentum, define the end of the move if you time it correctly. And it doesn’t work 100% of the time, well nothing does. But the only time that I would look for a trend reversal is late in a trend. I’m not going to look for it early in the trend.

So we have waves 1, wave 3 or 5 and so. It wouldn’t be until wave 5 that I would actually look for some kind of a divergence like we get here on the RSI indicator strategy with that. So early on trend? No. because here’s what you have to understand. Even though well, for example here we get a divergence. Don’t we? Right there. Higher high there, lower high here on the RSI.

BAD INDICATOR DIVERGENCE SIGNALS

So what happens is that yes there is a slowing of momentum if you will. But that does not necessarily mean it’s a reversal of momentum. Just because momentum comes out of the market. Okay, so we don’t get as big as swings, and what happens is, yeah the market does go sideways for a little while. But that’s all that means. And then it continues up.

So timing, and being able to, this is why wave counting comes in. so effectively is to know how far/long you are in that trend, the trend is your friend until the end. So the trend is your friend, your best friend early in a new trend. And earlier the better. That’s when I want to enter a trend, is at the very beginning of when it’s identified. Now I don’t want to get in late to a trend, in fact that’s the only time I actually would look for reversals. So that time of momentum shift is more likely to result in a reversal of a trend.

Now here is an example where we do get a 5 wave trend which is average. 1, 2, 3, 4, 5. We do not get a divergence on RSI indicator. So you get maybe look at, it’s not even really a divergence there. Because price is coming down at that same time. We had a5 wave but no real divergence so trends do not always end with momentum shifts. Sometimes they end with actually one of the best signals that I like to look for the end of a trend is the high volume spike.

THE CONFLUENCE OF EVIDENCE FOR TRADING STOCKS, FOREX AND FUTURES

You can’t trade any indicators. So RSI, stochastics, MACD, CCI, whatever you’re trading, none of them can be traded alone. Each one of them is a tool, and that’s it. That’s all they are. So use it as one piece of evidence, one tool in your toolbox. These are called indicators, they are not called moneymakers, and there’s a reason for that because they don’t make us any money.  They are just simply, there’s nothing magical about indicators. They are just mathematical formulas. That’s all they are.

So they are never wrong in the sense that you plug numbers in one side and they bring out the value of the other side, and that’s always correct. But then you have to take that information, plug it into a viable trading methodology in order to make money. And then trade it effectively with discipline, and with money management and risk management, which is utterly important. So those are the keys. Now I’m going to leave you with one last piece of controversy, and that is this.

THE RSI SCANDAL

RSI is not a true momentum indicator, in fact the indicator is commonly referred to as momentum indicator often seen as leading indicators, CCI, momentum, RSI here, stochastics, MACD. Those are commonly called momentum indicators but really they’re not. They are velocity or rate of change indicators, and the reason for that is that they are just measuring the rate of change of price. But momentum is actually the product of mass times velocity. These indicators are just velocity indicators.

So in the markets, in order to incorporate mass into it, we would have to use volume as well. And these indicators do not consider volume, therefore they do not consider mass. Therefore they are not literally momentum indicators. So there you go, another piece of controversy for you from Top Dog Trading.

Anyway, in our next video, in part 3, we’ll look at that, and we’ll look at how to solve that problem and create a true momentum indicator based around the RSI indicator strategy.

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