Taking RSI to the Next Level

The RSI or Relative Strength Index is one of the most popular and classic indicators that is used by
technicians far and wide. Developed by Welles Wilder, the RSI has been one of if not my favorite
indicators since very early in my career. I probably started using it by reading Murphy and other
Technicians talk about the classic indicators. In my research I came across Andrew Cardwell who
was said in a few places to be the person who really refined RSI analysis to get the most out of it. In
fact many say Andrew knows more about using the RSI than Wilder himself. I contacted him to see if
I could learn more about how to use the RSI. Not only were Andrew’s books out of print, he also was
not doing much speaking anymore and at the time didn’t have a website. After talking with Andrew
for a while, I decided to get his seminars which is where it all began. During the time I was studying
the seminars I was also reviewing a few days a week with Andrew himself. After the more than 24
hours of audio with endless charts along with regular reviews, I had learned a ton that doesn’t show
up in basic RSI work in most technical books. Going through the course in the beginning was like
trying to take a sip of water from a fire hose! I went through the courses 3 time in a period of 4
weeks and still don’t think I caught everything. Since finishing the courses almost 5 years ago
Andrew and I have become friends and continued to review charts when we think something is
happening. More recently Andrew put together a small group of students into a private trading
group that reviews markets and shares ideas utilizing his RSI work. He calls this his RSI Edge think
tank. Andrew is not only a terrific technician he is also a great mentor and the second best coach I
have had the pleasure to work with (behind only my father who was a state champion basketball
coach). In the end I got a lot more than just a seminar on RSI. Today Andrew has his website
www.cardwellrsiedge.com or email him at Andrew@cardwellrsiedge.com where you can get his
seminars without the heavy research it took me. I will vouch for the seminars being well worth it for
anyone who uses RSI as a primary indicator and is serious about trading. In this series I won’t even
be able to cover near the detail I learned, but I do want to put more color on much of the
information that is already out their in places like www.stockcharts.com as well as Connie Brown’s
and John Hayden’s books about what I view as Andrew’s work. I know I learned a ton from my time
working with Andrew and hope to pass a little along here as well as give credit where credit is due.
The Chart below is an example of a basic chart setup I have from just one angle of Andrews RSI
analysis. These are not the charts I usually put up on Charlty, but if I am serious about buying
something this is just one of the RSI configurations I will use in my analysis. I will use these charts in
this series so get familiar with them. Andrews’s analysis has changed the way I look at RSI, Charts
and Trading for the better.

RSI Bull and Bear Ranges

One of the most widely used ideas that Andrew developed on the RSI some 20 years ago is the bull
and bear ranges. This idea is based on a security having a different character depending on when it
is in a bull move or a bear move. We all know this happens, but to spot it early is the key. The
normal range for RSI is said to be 30-70 which works OK if you know how to use it, but Andrew saw a
shift when markets changed character. So it made since to adjust up the range to 40-80 in bull runs
and down to 20-60 in bear runs. Once you are aware of it, the range shifts are easy to see on many
RSI charts like the one below.

I chose a chart with some volatility to illustrate these shifts. MSFT has moved up and down for the
last two years giving many range shifts for us to look at.

I have market all the range shifts with horizontal lines colored in green for shift to bull and red for shift
to bear so you can see this concept at work on one of my RSI templates. There are a couple of shifts
that could almost be called whipsaws, but if the trade was managed right you should have been able
to extract some money with this knowledge alone. This is just with the textbook ranges. I also
marked an important pattern that we will come back to on this chart in another post that way we can
see how it played out real-time. As with all technical formulas you will get spikes and overshoots so
some interpretation will be necessary, but the critical 40 and 60 levels should not be breached for long
without shifting your ranges. I have marked two such spikes on the chart. You will also certainly get
some securities that just don’t respect technical patterns so remember this is part of analysis, not a
trading system.

Now all of that you can get from www.stockcharts.com in their RSI section as well as other sources;
so let’s go a little further and see how we can anticipate a shift. You should definitely use this in
conjunction with other indicators and price positioning taking a weight of the evidence approach if you
are going to try and anticipate a shift. The key is to watch the opposite barrier of the range you are in
for early warning. That means in a Bull range you should not only be watching 40 on the downside,
but keep a close eye on 60 when it moves up. In a bull range when RSI has trouble rebounding over
60 after a pullback, the trend is getting tired and could be ready to reverse. The opposite will hold true
for a bear range. Of course, there will be times you get both price and RSI will not reverse but move
sideways with RSI oscillating between 40-60. This muddling is more likely when price is in a box or
triangle type formation; but often the tired trend that cannot get RSI back above 60 after a run will be
in the process of a reversal. I would consider this a modified failure swing. Let’s look at the same
chart with the old lines marked in Grey and the new line marked in red and green.
As you can see it sped up every signal improved entries and exits. You can also use all the signals
as entries long or short and use other trade management tools to take you out of the trade (which I
might suggest). In a couple of cases on this chart the entries were substantially better if you
anticipated the shift. Now be sure that trying to anticipate does increase the risk of a failed move, but
the point that you know you are wrong is closer as well. The age old dilemma in trading: get in earlier,
take on more risk and more potential reward or wait for confirmation, have a higher winning
percentage and capture less of the move. It is all about Style on that one.

You can see that as we start to peel back the layers of the RSI, it is not just another indicator that
gives overbought and oversold signals. Today we learned one way to use it as a trend identifier.
Now that we know how to identify the trend, the next installment in the series will show you how to tell
when a trend is about to accelerate in either direction using RSI. Stay tuned.

Moving Averages on RSI

Now that we know the ranges for RSI that help us identify the current trend, the next step is to figure
out how to identify the most explosive part of the move. This would be the acceleration phase of a
trend. Using the range boundaries and adding moving averages you can get confirmation of a trend,
but you can also get a signal when the trend is likely to accelerate. The two moving averages that are
used for this portion of the analysis are the 9 period simple moving average (sma) and the 45 period
exponential moving average (ema). The same moving averages are used on price in most charts.
This idea works by following the moving averages of the indicator as they move with the indicator
using 40, 50, and 60 as signal levels to the trend. Now the signal actually depends on which direction
the average moves through not just which zone it is sitting in at a point in time. Using the 9sma for
the shorter trend and the 45ema to measure the longer term trend give two distinct perspectives of the
move. I have hidden the actual RSI on these charts to focus better on the averages. So when the
9sma moves over 40 then your trend is turning up. When it moves over 50 the trend is confirmed, but
once it move over 60 you should see almost immediate acceleration to the upside in many cases.
The same works in reverse, so when the 9sma moves below 60 then trend is changing from up to
sideways or down, below 50 then you should be trending down and below 40 you see acceleration to
the downside. Let’s see this in action. This first chart is of AMAT and it has signals on both sides to
look at and get an idea of this action. Click on any of the charts to open in a new page for better
viewing.

In the charts below we will focus more on the 40 and 60 crosses. The lines showing a cross above 60
or below 40 anticipating acceleration are the thicker and denoted by blue arrows (ignore the other
symbols they are other signals I have programmed on these charts). The moves above and below 50
(marked with dotted line) are more important when the 9sma doesn’t move outside the 40 and 60
boundaries to give a normal signal. The charts come from the StockTwits 50 for strong trends and
various sectors for downtrends so we can cover both directions.
First we see GTLS in a big run higher with some decent signals along the way. A key value to this
analysis is that the acceleration signal comes right about the time many would be saying indicator is
overbought and too high. Also notice the downtrend signals were not that powerful here showing the
strength of the uptrend.
JAZZ is also only giving a few stronger signals, but the one in the middle is a monster. Notice the
orange 9sma didn’t move below 60 the entire run. The latest signal has definitely been profitable, but
it is still to be seen how much it will yield.

A couple of things to note on the downside charts below is that the signals are more prevalent and
erratic which is normal for downside moves. This means you have to adjust your rules on how to
trade just as you should with anytime you are shorting. One example of this would be to use one
barrier to initiate the short and a different barrier level to get out or some other risk management
measure. On the short side risk management should always be tighter.

Here we look at F and see there are many more signals that can jerk you around, but the overall
guidance was pretty solid. On many signals you might have to endure a retracement before going
lower, but that is shorting for you. Also, if you had different risk management in place and taken the
original signal at the beginning of each leg you could have remained in the trade a while depending on
your tolerance for volatility.
DLB is also in a downtrend and has been for a while, but this chart has given us strong signals on
both sides. You can see at the left side of the chart there is a good run up which you could have
profited from, but since this is a chart for the downtrends let’s look at those. There are three
acceleration signals, all of which would have given you a profitable short. The acceleration signal in
January of this year would have yielded monster results. The latest signal was solid as well.

Now let’s look back at all these charts and look closer at the blue 45ema. You can see this average
moves slower and is less likely to go over 60 or below 40, but when it does you usually have a
stronger move. This moving average analysis also seems to have better success as a stand alone
idea on the long side, but when used with other analysis it can certainly add value in either direction.
Often I will use it to help confirm what I am seeing in the 9sma by simply looking at the slope of the
45ema. I did not mark these signals but you can see they tend to go with the longer trend.

Another good way to use these moving averages on RSI is to watch for the crossovers and
convergences almost like an MACD of the RSI. You can see clearly on the F chart as well as others
that many times the 9sma will find support or resistance at the 45ema adding good info about where
you are in the trend.

As with most technical analysis, this can be used on any security and any time frame, so t this info
and do some testing yourself to see how it might help your trading. Now if you are working with
www.stockcharts.com or many other charting options and can only plot one of the moving averages
I would go with the 9sma, but really that decision depends on your trading style

Next installment we will discuss Andrew’s most unique signals he developed on the RSI as we explain
positive and negative reversals.

Positive and Negative Reversal Patterns

Among the many nuances that Andrew extracted from the RSI in his research, the one I think that
defines the effort the best would have to be positive and negative reversals. These signals contribute
to my analysis in three distinct ways. They act as entry signals, give a way to measure trend strength,
and can provide a warning signal. We will go over each of these uses once we learn how they are
formed. Let’s use the WFC chart for this first example because it is sporting both signals over the last
year. I have labeled the signals in red and green lines, and have fully marked up the first positive
reversal on the chart to show construction and the target.

A positive reversal could be described as the opposite of a positive divergence. With a positive
divergence it comes at the highs of a move in an uptrend and you have a lower price with a higher
RSI. To make sure we are only concentrating on the reversal signals right now, I have cleaned most
everything else off the charts in this exercise. As you can see in the WFC chart a positive reversal
shows up in a pullback during an uptrend where the chart has a lower RSI with a higher price when
the pullback reverses. The negative reversal in the RSI is just the opposite. Negative reversals form
during the bounces in a downtrend. This works off the same concept as Can the MACD Identify a
Counter-Trend Move? where the velocity of the momentum indicator is disproportionately faster than
price movement in a counter trend move. With the RSI this indicator movement allows for these
reversal patterns to form. So we can see how the positive reversals are formed; now lets look at how
their targets are measured and how to use them. As you can see on the left side of the WFC chart we
have a positive reversal that has fired and now is moving higher. I have labeled the X and Reference
point on the chart as well as the intervening high. Close values are used for all points in the
calculation. While many use these targets as a place to take profits, Andrew teaches that these
targets have value in trend analysis as well. In trend analysis it can play the important role of
confirming the strength of the trend in a couple of different ways, but first we have to know how to
measure the target. You calculate this by taking the difference in the close price of the reference
period minus the X period and then add that to the highest high close intervening. If a positive
reversal exceeds its target the trend is considered strong. When the signal fails to meet its target it is
a big clue of a potential reversal of the trend. I’ll save that for a little later, let’s start with using these
signals for entry signals.

Entry Signals

The positive and negative reversals give good entry signals on a pullback during a move. How often
are we looking at a chart that we missed the kickoff move and/or is in an accelerating trend and we
are having a tough time finding a place to get in? These signals give good entry points long for
positive reversals and short for negative reversals. The first two charts show some very good entry
signals in up trends.

The EP chart has been a very strong mover over the last year. One unusual thing about this chart is
the first positive reversal comes before an official range shift which is pretty rare. I have not seen
enough of them to say if they can give us an extra edge in our trading. EP has been firing signals all
the way up, even in March when a breakdown looked in the offing; RSI held at the 40 level and
formed a positive reversal showing the bulls were still in control. Most of the reference points would
have been pretty solid entries for swing and position traders. A couple took a while to kick in or had
slight drawdowns before continuing, but that is trading.
Everyone who even sniffs the markets knows NFLX has been in a monster trend, and many of those
observers are chomping it the bit to short this one. As you can see on the chart, the trend never
turned down, so if you were shorting you better be quick and nimble. The most hope the bears had
here was a quick spike down in March that turned out to be nothing more than a bear trap that didn’t
even close the preceding gap really frustrating the bears.

And on the downside:

BRCM has been in a downtrend this year, along the way RSI users were given many chances to short
the rips and bank some pretty good gains even at times the overall market was rallying. At this point
BRCM is very close to causing the final negative reversal signal to fail which would go along with the
resurgence in Semiconductors we started to see this week and signal a possible trend change.
I also used GOOG in the downtrend category, but actually this chart is giving us both signals.
However, in March GOOG gave us a good entry point at the first negative reversal which broke down
shortly there after.

As usual patterns to the downside are considerably quicker and more volatile to work with. Shorting is
not for the undisciplined or the faint of heart. These signals can be powerful especially when they
come right after a range shift and at other support and resistance points reinforcing the importance of
the price zone.

Trend Confirmation

I t is always comforting to see postives fire on a chart, but if the positive reversal comes soon after a
range shift from a bear range to a bull range it helps confirm the trend change as well as gives a good
pullback entry with a very high success rate. The MCD chart below shows us a positive reversal
right after the range has shifted which is one of the best trend confirmations and solidifies that the
bulls are holding the reigns tightly.
As the trend continues we see positive reversals forming after many of the pullbacks affirming the
trend each step of the way. As long as they are firing and meeting targets the trend is up. Once a
failed pattern appears, we should take notice

Failed Patterns

Failed patterns can be as important as those that succeed, especially after a long run up or down.
Late stage positive and negative reversal patterns are not as reliable as those in early stages so key
on the failures for this early warning. I have marked these failed patterns in many of the charts we
have already seen. These patterns often precede a trend change, but can be successful warnings
without ruining a chart. In LULU chart you can see we have two failed positive reversals that do lead
to a fairly quick retreat in the chart, but the strength in the underlying bid soon reappeared and the
trend resumed. Price action always overrules indicator signals.
This is to drive home the point that all analysis has a time when it doesn’t work in a textbook fashion.
That is why they still need us, because a good portion of technical analysis still falls under
interpretation due to the many factors that drive an individuals analysis. If it weren’t that way then
computers would do all the trading (not just 70% of it as we see now). But that is a topic for some
other time.

Today we isolated the positive and negative reversal signals so that we could concentrate on how
they work and what they can tell us on their own, but most good technicians will not rely on one
measurement. If you combine this with what we learned in the last two pieces you can see how RSI
is becoming a much more multifaceted toolkit. In the next post I will go over divergences and why we
all might be using them wrong.

Divergences are Often Detours

Every trader at some point deals with divergences as they learn technical analysis. Divergence is a
very generic term and can be applied to any two datasets, but most divergences are considered a
warning sign to the prevailing trend. It is a basic and simple rule of Technical Analysis. When using
divergences, more often than not people are talking about divergence of price from a momentum
indicator like the MACD, RSI or any of the many to choose from. But when we are discussing
divergences with RSI there is more to the story. Bullish and bearish divergences on RSI are a sign of
a loss of momentum in the current trend; however, further study showed that in most cases these
divergences are not necessarily a warning for the end of the trend, but more so for the potential end of
the immediate leg you are in. One of the big problems that technicians have with divergences is
identifying which one to act on. Once you have the rest of the RSI toolkit with the concept of Range
Shifts and Positive/Negative reversals you start can use them with divergences to help identify THE
divergence which can add a powerful edge to your positioning.

With RSI charts Andrew realized that divergences more often work as detours to a trend than they do
reversal of the trend. Of course some trends end with a divergence (more often in a downtrend), but
which divergence? It is really hard to tell alone, but when combined with the other nuances we have
learned about RSI it gets a little easier. For day traders and swing traders divergences if caught
correctly can certainly be profitable, but for trend traders and position traders RSI divergences need to
be looked at a little differently. I have marked up all the charts the same I have the entire series. The
MS chart below gives a good example having many divergences to choose from.

When looking through the RSI charts you will notice that more often than not you see a bearish
divergence show up in a bull range (notice in all the charts) often starting in the 70-80 range and
proceeding down with lower highs in the RSI while seeing higher highs in price. So if we reverse that,
bullish divergences show up in bear ranges often starting to form with an RSI low in the 20-30 range.
Since downtrends tend to be faster and cover ground quicker than in up trends you will not see as
many divergences before THE divergence shows up, but the concept still works.

As we can see with EQR, in a strong uptrend you can have many bearish divergences in a row as
prices march the trend forward with higher highs and higher lows. These swings can be very tight in a
strong trend or can be wide and loose but still making higher lows as the trend continues. As I stated
earlier, divergences can have good profit potential very short term, and if you pick the right one it
could be a full trend reversal. So let’s go through signs we can look for to see if we have the right
one.
One of the first things I would look for is if the bullish or bearish divergence to fall into a positive or
negative reversal. EQR shows multiple positive reversals on the chart. This would be my first clue of
a head fake because if I see a positive reversal per say, then the trend is innocent until proven guilty
with a failed pattern. We already know that a failed positive or negative reversal is a warning signal
so combining it with a bearish divergence give two clues of a trend change.

When EQR was showing bearish divergences the immediate pullback often will bottom with the RSI
well above 40 and fire a positive reversal which we already know is a sign of trend confirmation. If
you buy when the positive reversal appears, then you have a very well defined stop loss and target
that will give you confirmation of a good entry. As long as that positive reversal reaches its target, the
trend is still up and the bearish divergence was nothing more than a pause in the trend that gave a
good opportunity to get in or add more to a strong trend with a reasonable risk.

Now we will look at the downtrend in HPQ which you don’t get as clean or as many signals. What you
do get is plenty of bullish divergences that rise into negative reversals that could have been very
profitable.
The other important thing to look for is where the RSI terminates on the next swing after the
divergence bottoms. It is usually not until the RSI tops out right around the 60 range that you are
more likely to see a change in the trend (back to the range rules). Traditional RSI analysis says that
when RSI can’t get back above the normal overbought zone at 70 then you have a failure swing. With
Andrew’s work 70 is a level to look at, but we know the more important level is 60 due to the range
rules. Therefore, if we get a peak below at or below 60 (or trough at or above 40) in the RSI whether
it is a divergence or not we should pay attention. I have marked many of these failure swings on the
charts above, but we can see in the IWM below that we have both signals showing. One in the
beginning of the chart and a negative swings through the chart. We also get a good reminder that not
all signals work as the markets started to chop sideways, but they were worth watching closely. Also
realize it looks like we may be getting some failure signals here as I write this, but it will take another
day or two to confirm.
The charts above show how we can take our RSI toolkit and add it to common divergences on the
RSI to help narrow down the ones we actually take. Of course none of these tell you to buy or sell at
the exact turning point, but most get you in or out in a very reasonable area if the trend is changing.
They are also very good at telling you when it is not which is just as important. In the next piece I will
talk about how size does matter especially for faster traders. So all you day and swing traders stay
tuned.

Smaller Signals can Pack a Punch

As I wind this series down on Andrew’s RSI work, I finally have something for the short term traders.
The last tip I will leave with you is that size does matter at least when it comes to RSI signals. When I
say size, I mean periods from the beginning (the x point) to the signal (the reference point). It goes
opposite to what you might think, smaller (shorter) the signal the more powerful it is likely to be if it
fires. By more powerful I mean the distance covered by the immediate move once it goes. This
works with positive and negative reversals as well as bullish and bearish divergences. These
signals can also come anywhere within their respective ranges. These compact signals can be like
C4 when they explode. Now this doesn’t mean you will necessarily change the larger trend, but you
can very likely get in on a good strong move most often immediately following a very tight signal. It
can also help you enter a relentless trend more confidently on a one two four day pullback into a
reversal pattern. In my charts I make sure pay close attention to 2 - 5 period signals as I believe
these can be rockets if they go. This is not to say that longer term signals are not important to trend
management, but the compact signals are worth looking for from a trader’s perspective. In my
experience these short term signals show up more often with bullish divergences and positive
reversals, but they do show up in the bearish divergences and negative reversals.
Let’s look at some charts that provide these compact signals. These will be clean charts only labeling
the compact patterns of 5 periods or less with the number of periods above the arrow. They all are
likely to have tons of other RSI signals we have talked about, but I want to make sure we are
focusing. In the real world getting a longer signaled followed directly by one of these shorter signals is
a good combination. I am also going to use some of the securities we have already seen in the
series. I even hinted to the importance of these signals on the MSFT chart in an earlier post as it was
happening.

This MSFT chart has a few signals that we could react on. The first is a 4 period PosRev (positive
reversal) followed by a 2 period PosRev into a 3 period BearDiv (bearish divergence). These signals
were good for immediate pops but didn’t turn into anything big right away. If you rode it to the top it
was about 5%.not much of a jump. Its was the recent 2 period PosRev I was hinting to in the first
post. It shot up the next day as many of them do, but didn’t run too much further before stalling with
the broader markets. For those position traders who might use that 2 period signal as an entry, it still
doesn’t look too bad. There are other movers Next lets look at another favorite PCLN which had
some good signals in April and May of this year.
PCLN gave some good signals in April and May of this year. First 2 period PosRev worked well and
lead to the big run into the back to back BearDiv 3 and 2 period signals. Those signals lead almost
immediately to a drop where the first leg bounced right into a 5 period NegRev which led to a
continuation. For the day or swing trader those patterns added to a good plan are very helpful. The
signals in GOOG below were powerful, but almost impossible to trade in some cases.

Now this chart starts with a 5 period NegRev that gapped down and was too extended to trade.
However, the 4 period BullDiv started a vicious move which paused into a 3 period PosRev that again
gapped up and looked to extended until it paused into a 3 period PosRev that ran higher quickly into a
five period PosRev that is currently on shaky ground. I circled this area because before today it
looked like the last signal was going to fail. One thing to watch out for and be a little tighter on stops
is when you get multiple signals in a row at elevated RSI levels. Doesn’t mean you can’t take the
trade; just make sure you use a good plan to encompass the entry. Next we have ALXN gave good
signals before and during the recent run higher.

The first signal on the ALXN chart is a 2 period BullDiv that started the run up into a two period
divergence which is followed up by an immediate 2 period PosRev. This is a pattern that will show up
over and over in strong trends, so if you decided to fade it on the initial BullDiv you must be nimble
enough to get out and preferably reverse the trade on the PosRev that follows. The first one or two of
these are usually good, but if you get a constant string which will happen from time to time, eventually
it will break the other way, so again with the good plan and risk management. Next I have a
tremendous trend in JAZZ which I will not be going through all the signals. You can see why. Many
look small on the chart, but if you go to those signals on your charts and zoom in you will see most
were more than 10% in a very short window.
This is the definition of one of those relentless trends that are said to be hart to find and entry. Here
are a few ways you could have gotten on the JAZZ train without too much anxiety. What a great
chart.

We will end with ZAGG where we had a patter fire just a couple of days ago so we can see how it
plays out in real-time.
I have used these signals in my analysis for years and love watching to see what they can become.
This is another tool to add for short term traders as well as for those who want a longer timeframe and
look for places to pyramid their positions.

This post brings this series to a close of the last piece. There is much more to Andrew's work, but I
believe there is something in here for almost any type of trader out there. I hope it helps as many as
possible better understand how to use the toolkit that the RSI indicator has become thanks to
Andrew’s work. I know it will and has helped me tremendously already. These ideas have proven
themselves through all types of markets and securities from monthly charts all the way down to 5
minute charts. Use this information to experiment yourself and explore how it best fits your style.