identify and monitor the current trend.

Of course, the length of the moving

INDICATOR IN FOCUS: TREND ANALYSIS
average selected, or time period assigned to the oscillator used, should be

USING THE RSI predicated on whether it is for shorter term or longer term trading.

BY ANDREW CARDWELL DIVERGENCE

The RSI was originally developed by Wells Wider (Trend research,

The ideal indicator would be one which offered the capability to identify and
Hendersonville NC) in the late 1970’s. It was designed as a momentum
monitor the current trend, highlight overbought and oversold extremes
oscillator to help identify divergences (non-confirmations) between price
within that trend, and give early warnings of a trend change. The Relative
movement and momentum. The basic premise was two-fold:
Strength Index (RSI) is such an indicator, offering the best of all worlds.
1. That momentum would peak before price in an uptrend or bottom first
in a downtrend,
The RSI is probably one of the most dynamic and powerful indicators
2. After a correction as price made a new high (or low), momentum would
available to today’s traders. One of the most widely used, it is available on
fail to make a new high (or low), and not confirm the new price
almost every technical analysis software program. It is also one that is most
movements.
often misunderstood, misused and underrated. The RSI can be used as
This non-confirmation is characteristic of most momentum based indicators
either a completely independent trading model or an enhancement of your
and has been duly noted and accepted as divergence. Basic price/momentum
current technical approach. As a completely independent trading program it
divergence can and does help to identify an extreme overbought or oversold
can be used for identifying: Trend, Support and Resistance,
condition in the market’s momentum. However, most traders fall prey to
Overbought/Oversold Levels, Divergence (Bullish/Bearish), Trend Change and
this concept of divergence and see it as the end or reversal of the prevailing
Reversal, and Price Targeting.
trend of the market. When Bearish Divergence develops, the Bears come out
of hibernation and want to sink their claws into what they feel will be the
Most technical indicators employed by traders can, in general, be categorized
next Bear Market. As Bullish Divergence develops, the Bulls are ready for a
as either trading or trending technical studies. Momentum oscillators are
reversal of trend and the start of a Bullish stampede to the upside.
usually considered to be trading indicators, as they use market volatility to
identify overbought or oversold valuation levels. Moving average systems
would be considered trending studies, as they smooth volatility to help
OCTOBER 2013 ATMASPHERE | 5
All would be right with the world if markets were to reverse from simple
divergence. But there are times when sentiment and momentum are so
strong that the market continues to make new highs (lows), which will keep
the RSI at overbought (oversold) levels for extended periods of time.
Momentum and price corrections, when they do materialize, are usually
sharp and swift. After these brief respites the market is then ready to
resume its normal upward (downward) trend. With each successive new
high (low) and divergence formed, anxious traders are ready to call for a top
(bottom) and reversal of trend. However, in strongly trending markets,
multiple divergences can and do develop, which only lead to corrections of
the overbought (oversold) condition of the market. If a trader attempted to
take positions based solely on divergences, he or she would need deep
pockets and eventually exhaust his or her trading capital.

IMPORTANCE OF TREND
Most traders and analysts use RSI as an oscillator to identify
overbought/oversold levels and divergences, but those are just two of its
analytical applications. The RSI’s more dynamic and significant contributions
as a tool are its ability to:
1. Identify the current trend and keep the trader positioned property in
the direction of that trend; and,
2. When market conditions develop, give early warning of a possible
impending trend change, whereby the trader can reverse the position.

Since markets generally trend approximately 60-70% of the time, trend

analysis, identification and change should be foremost in the mind of the
trader. The ability to recognize a trend change quickly, reverse a position, The parameters for the RSI values are 0-100. Extremes for overbought and
and trade in the direction of that next trend is the skill which traders must oversold levels vary slightly, depending on the period value selected by the
develop to be successful. trader’s perspective. Day traders or shorter-term traders will generally
employ values such 3, 5, 7, or 9, and longer term traders usually use either 9,
By having a position in tune with the trend, the trader will have the 14, or 21. The original value of the period established by Welles Wilder was
opportunity to participate in the bigger market moves which generate larger 14, which was based on being the half-cycle length of the 28 day or lunar
profits. When positioned properly with the trend there are also fewer cycle. Using the 14 period value on close as the standard for most of the
trading decision that have to be made. Since markets trend, any surprises markets we follow, we use the following as guidelines:
which may develop in market activity are usually in the direction of the RANGES OF RSI:
intermediate and longer term trends. 1. “Normal” Range: 30 – 70
2. “Uptrend (Bull Market): 40 – 80
3. Downtrend (Bear Market): 20 – 60
4. Trading Range: 40 – 50 points

RSI RANGES

OCTOBER 2013 ATMASPHERE | 7

 bullish, momentum takes prices to higher levels. We adjust the range of RSI
to account for these higher levels. Using the same 40 point range based on
the 30 and 70 point values, Uptrends show 80 as overbought and 40 as
oversold. As long as the market stays within the 80/40 range (uptrends), we
should see prices make higher highs and higher lows. When sentiment is
extremely bearish, momentum normally takes prices to lower levels due to
liquidation and the absence of buying. Applying the same 40 point ranges for
downtrends, 60 shows as overbought and 20 as oversold. As long as the
range of 60/20 remains intact, we should continue to see lower lows and
lower highs. Taking note that the range has shifted from 80/40 to 60/20
should be a strong indication that the trend has shifted from being in an
uptrend to being in a downtrend. By employing range analysis to RSI, not
only can a trader identify uptrends from downtrends, but he will also stay
with the trend longer than he normally would have and hold a position for
maximum capital appreciation.
We consider the “normal” range to be the levels between 30 and 70, which is
where 60 – 70% of trading activity takes place. When a market is in a gradual
uptrend (or downtrend) the RSI will normally ebb and flow within this range
as the market trends higher (or lower). The levels for an overbought market
can range from 70 up to 80 or 90, depending on the time period selected.
For an oversold market the range may be from 30 down to 20 or 10. Taking
the average of the overbought and oversold values we established 80 and 20
as better values for consideration of overbought and oversold levels. The
standard 14-period RSI normally stays within a range of80 and 20.
People are bullish by nature, so when markets start to move we must adjust
for this shift in sentiment and psychology. When sentiment is extremely
 the “3 Keys to Success,” Trading Program, Patience and Discipline. Follow
your trading program, have the patience to wait for the signal and the
discipline to stay within the parameters of your program and stay within
yourself.

Andrew Cardwell, president of Cardwell RSI EDGE, Inc.,

(www.cardwellrsiedge.com) provides consultation and
commentary for his RSI course students and his
Cardwell Private Client Group. He has taught his

proprietary RSI Basic and RSI EDGE courses to individual to students in 27

countries. As a very respected and sought-after lecturer, he has presented at
some of the most prestigious worldwide financial conferences. You can reach
him at [email protected].
As an exercise to further educate yourself, take the time to go back and
review your trades over the last 6-12 months and apply the 80/40 and 60/20
range rules. You will probably realize that you were positioned properly in a
trend, and even though you made money on the trade you offset the
position much too soon. If you lost money on a trade, you were probably
short in an uptrend (80/40) or long in a downtrend (60/20).

THE “3 KEYS TO SUCCESS”

If you include the guidelines which I have presented here for RSI range
analysis, I believe you will find that they will help you make better trading
decisions and stay in tune with the trend. As a final note, always remember

OCTOBER 2013 ATMASPHERE | 9