Mastering RSI: Bull & Bear Ranges, Swing Concepts, and Live Chart Analysis

The Relative Strength Index (RSI) is a momentum oscillator that measures the speed and change of price movements. It is primarily used to identify overbought or oversold conditions in a traded asset. RSI values range from 0 to 100 and were developed by J. Welles Wilder in his 1978 book, "New Concepts in Technical Trading Systems."

Calculation

RSI is calculated using the following formula:

\[ RSI = 100 - \frac{100}{1 + RS} \]

Where RS (Relative Strength) is:

\[ RS = \frac{\text{Average Gain}}{\text{Average Loss}} \]

The Average Gain and Average Loss are typically calculated over a 14-period timeframe. The steps to calculate RSI are:

1. Calculate the Gain and Loss:

- If the closing price is higher than the previous close, the difference is considered a Gain.

- If the closing price is lower than the previous close, the difference is considered a Loss.

- If the closing price is the same, both Gain and Loss are zero.

2. Calculate the Average Gain and Average Loss:

- For the first 14 periods, the Average Gain is the sum of gains over the past 14 periods divided by 14.

- Similarly, the Average Loss is the sum of losses over the past 14 periods divided by 14.

- For subsequent periods, the Average Gain and Loss are smoothed using the formula:

\[ \text{Average Gain} = \frac{(\text{previous Average Gain} \times 13) + \text{current Gain}}{14} \]

\[ \text{Average Loss} = \frac{(\text{previous Average Loss} \times 13) + \text{current Loss}}{14} \]

3. Calculate the RS and then the RSI:

- Once the Average Gain and Average Loss are obtained, calculate RS and then RSI.

Interpretation

• Overbought and Oversold Levels:

RSI values above 70 typically indicate that a security is becoming overbought or overvalued and may be primed for a trend reversal or corrective pullback in price.

Over the years, the Relative Strength Index (RSI) has shifted in its level thresholds. Nowadays, an RSI level of 80-85 is ideal for identifying index reversals from the top, 85-90 levels work best for large-cap stocks, and a level around 90-95 is effective for mid and small-cap stocks.

RSI values below 30 typically indicate that a security is becoming oversold or undervalued and may be primed for a trend reversal or corrective rally.

Over the years, the Relative Strength Index (RSI) has adjusted in its threshold levels. Today, an RSI level of 20-25 is ideal for identifying index reversals from the bottom, 15-20 levels are most effective for large-cap stocks, and a level around 10 is suitable for mid and small-cap stocks.

For RSI threshold levels to be effective, it's crucial to consider the time frame, as it plays a significant role in decision-making.

Higher time frames (daily, weekly, and monthly) are more reliable for applying the mentioned RSI levels for indices, large caps, mid caps, and small caps.

In shorter time frames like 5, 15, and 45 minutes, as well as hourly charts, it’s preferable to use an RSI band of 10-15 for oversold conditions and 85-90 for overbought conditions when making trades.

- Divergences:

Regular Bullish Divergence

A bullish divergence occurs when the price of an asset makes a new low, but the RSI forms a higher low. This divergence suggests that although the price is declining, the selling momentum is decreasing, which can indicate a potential reversal to the upside.

Characteristics:

- Price Action: Lower lows in price.

- RSI Action: Higher lows in RSI.

- Indication: Decreasing bearish momentum, potential trend reversal to bullish.

Example Scenario:

1. Initial Drop: The price of a stock drops from 100 to 90, and the RSI falls below 30.

2. Further Drop: The price continues to drop to 85, but the RSI now only drops to 35.

3. Reversal Signal: Despite the new price low, the higher low in RSI suggests weakening bearish momentum, potentially signaling a buying opportunity.

Chart Example:

Price: 100 90 85

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RSI: 30 35

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Hidden Bullish Divergence

In the realm of technical analysis, recognizing potential trend reversals is key to making successful trades. Among the array of tools and indicators available, hidden bullish divergence stands out as a subtle yet powerful signal for traders. Although it might not be as commonly discussed as its regular counterpart, hidden bullish divergence can offer valuable insights into market trends and help traders make informed decisions.

Hidden bullish divergence occurs when the price of an asset makes a higher low, while the corresponding technical indicator (such as RSI, MACD, or Stochastic) makes a lower low. This divergence suggests that the underlying momentum is stronger than the price action indicates, pointing to a potential continuation of the existing uptrend.

Key Characteristics of Hidden Bullish Divergence

1. Higher Low in Price: The price must make a higher low, indicating that the asset is maintaining its upward trajectory despite some pullbacks.

2. Lower Low in Indicator: At the same time, the chosen technical indicator should make a lower low, creating a divergence between the price action and the indicator. This signals that the selling pressure is weakening.

3. Continuation of Uptrend: Unlike regular divergence, which typically signals a trend reversal, hidden bullish divergence indicates a continuation of the current uptrend. It serves as a cue that the bullish momentum is likely to persist.

Hidden bullish divergence is a valuable tool for traders for several reasons:

1. Early Indicator: It provides an early signal of potential trend continuation, allowing traders to position themselves ahead of the crowd and capitalize on the ongoing bullish momentum.

2. Trend Confirmation: For trend-following traders, hidden bullish divergence offers confirmation that the uptrend is still intact. This can be particularly useful in volatile markets where false reversals are common.

3. Risk Management: Understanding hidden bullish divergence helps traders manage their risk more effectively. By anticipating the continuation of an uptrend, traders can set more appropriate stop-loss levels and safeguard their investments.

How to Spot Hidden Bullish Divergence

1. Choose an Indicator: Select a reliable momentum indicator such as the Relative Strength Index (RSI), Moving Average Convergence Divergence (MACD), or Stochastic Oscillator.

2. Analyze Price Action: Look for instances where the price makes a higher low compared to a previous low.

3. Compare with Indicator: Check if the chosen indicator makes a lower low during the same period.

4. Confirm with Volume: For added confirmation, consider analyzing trading volume. Increasing volume during the formation of a higher low in price can strengthen the case for hidden bullish divergence.

Let's consider a practical example using the RSI indicator. Suppose a stock's price bottomed at 50, then rose to 60, and later retraced to 55 before rising again. Meanwhile, the RSI indicator bottomed at 30 when the price was 50, rose, and then dropped to 25 when the price was 55. Here, the price made a higher low (55 compared to 50), but the RSI made a lower low (25 compared to 30), indicating hidden bullish divergence and suggesting the continuation of the uptrend.

Live Chart

Hidden bullish divergence is a potent yet often overlooked tool in a trader's toolkit. By recognizing the subtle signs of strengthening momentum, traders can gain a strategic edge in anticipating market movements. Incorporating hidden bullish divergence into your technical analysis can enhance your ability to navigate the markets confidently, make better trading decisions, and achieve more favorable trading outcomes.

Remember, like any technical indicator, hidden bullish divergence should not be used in isolation. It is most effective when combined with other analysis tools and sound risk management practices.

Bearish Divergence

A bearish divergence occurs when the price of an asset makes a new high, but the RSI forms a lower high. This divergence suggests that although the price is rising, the buying momentum is decreasing, which can indicate a potential reversal to the downside.

Characteristics:

- Price Action: Higher highs in price.

- RSI Action: Lower highs in RSI.

- Indication: Decreasing bullish momentum, potential trend reversal to bearish.

Example Scenario:

1. Initial Rise: The price of a stock rises from 100 to 110, and the RSI climbs above 70.

2. Further Rise: The price continues to rise to 115, but the RSI now only reaches 65.

3. Reversal Signal: Despite the new price high, the lower high in RSI suggests weakening bullish momentum, potentially signaling a selling opportunity.

Chart Example:

Price: 100 110 115

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RSI: 70 65

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Hidden Bearish Divergence

Hidden bearish divergence occurs when the price of an asset makes a lower high, but the corresponding indicator (such as the RSI, MACD, or Stochastic) makes a higher high. This divergence between price action and the indicator suggests that the underlying strength of the price movement is weakening, indicating a potential continuation of the existing downtrend.

Key Characteristics of Hidden Bearish Divergence

1. Lower High in Price: The first requirement for hidden bearish divergence is that the price makes a lower high. This signifies that the asset's price is struggling to reach previous high levels.

2. Higher High in Indicator: Simultaneously, the chosen technical indicator should make a higher high. This creates a divergence between the price action and the indicator, signaling that the momentum driving the price upward is not as strong as it appears.

3. Continuation of Downtrend: Unlike regular divergence, which often signals a trend reversal, hidden bearish divergence indicates a continuation of the current downtrend. It serves as a warning that the bullish momentum may be fading and the bearish trend might resume.

Hidden bearish divergence is a valuable tool for traders for several reasons:

1. Early Warning System: By identifying weakening momentum before it is reflected in the price, hidden bearish divergence provides an early warning of potential trend continuation. This allows traders to adjust their strategies accordingly.

2. Confirmation of Trend: For traders who rely on trend-following strategies, hidden bearish divergence offers confirmation that the downtrend is likely to continue. This can be especially useful in volatile markets where false reversals are common.

3. Risk Management: Recognizing hidden bearish divergence can help traders manage their risk more effectively. By being aware of potential trend continuations, traders can set more appropriate stop-loss levels and protect their investments.

Identifying hidden bearish divergence involves a few simple steps:

1. Choose an Indicator: Select a reliable momentum indicator such as the Relative Strength Index (RSI), Moving Average Convergence Divergence (MACD), or Stochastic Oscillator.

2. Analyze Price Action: Look for instances where the price makes a lower high compared to a previous high.

3. Compare with Indicator: Check if the chosen indicator makes a higher high during the same period.

4. Confirm with Volume: For added confirmation, consider analyzing trading volume. Decreasing volume during the formation of a lower high in price can strengthen the case for hidden bearish divergence.

Practical Example

Let’s consider a practical example using the RSI indicator. Suppose a stock’s price peaked at 100, then retraced to 90, and later rose to 95. Meanwhile, the RSI indicator peaked at 70 when the price was 100, dropped, and then rose to 75 when the price reached 95. Here, the price made a lower high (95 compared to 100), but the RSI made a higher high (75 compared to 70), indicating hidden bearish divergence and suggesting the continuation of the downtrend.

Live Chart

Centerline Crossovers

- An RSI reading crossing above the 50 level indicates increasing bullish momentum.

- Conversely, an RSI reading crossing below the 50 level indicates increasing bearish momentum.

Practical Considerations

1. Combining with Other Indicators:

Use RSI alongside moving averages or MACD for more robust signals.

2. Adjusting RSI Period:

Experiment with different RSI periods (e.g., 9, 14, 21) to suit different market conditions or assets.

3. Risk Management:

Incorporate stop-loss and take-profit levels to manage risk effectively.

4. Market Conditions:

RSI performs differently in trending versus ranging markets. Adapt strategies accordingly. RSI can be used to confirm the strength of a trend. A sustained RSI above 50 often supports a bullish trend, whereas a sustained RSI below 50 supports a bearish trend.

RSI can help identify different phases of the market (e.g., accumulation, uptrend, distribution, and downtrend) based on the RSI levels and their behavior over time.

Limitations

- False Signals:

RSI can sometimes generate false signals, especially in strong trending markets where the RSI might stay overbought or oversold for extended periods.

- Lagging Indicator:

As with many technical indicators, RSI is a lagging indicator, and it bases its readings on historical price data. This means it might not always predict future price movements accurately.

- Complementary Use:

It is advisable to use RSI in conjunction with other technical analysis tools and indicators to confirm signals and improve the accuracy of trading decisions.

Practical Example with Backtested Data

To illustrate the practical use of bullish and bearish divergences, let's consider a hypothetical backtested scenario on Nifty 50 over the past 10 years.

Backtesting Parameters:

- Period: 2013-2023

- Asset: Nifty 50 Index

- RSI Period: 14 days

- Bullish Divergence Buy Condition: Price makes a lower low, RSI makes a higher low.

- Bearish Divergence Sell Condition: Price makes a higher high, RSI makes a lower high.

Results:

- Number of Bullish Divergence Trades: 30

- Number of Bearish Divergence Trades: 25

- Winning Trades: 65%

- Losing Trades: 35%

- Average Gain per Winning Trade: 6%

- Average Loss per Losing Trade: 3%

- Overall Gain: 20%

RSI Range Concept

RSI 40-60 Concept and Range Shift Concept (20-60 and 40-80)

Beyond these traditional uses, RSI can also be interpreted using concepts like the RSI 40-60 range and the range shift concepts of 20-60 and 40-80. These concepts help traders understand the prevailing market trend and its strength.

RSI 40-60 Concept

The RSI 40-60 concept involves using the 40 and 60 levels as key thresholds to gauge the strength and direction of a market trend. This concept helps in identifying bullish or bearish trends more clearly and provides signals for potential entries or exits.

Key Points:

- Bullish Market: When the RSI consistently stays above 40 and often peaks above 60, it indicates a bullish market. The 40 level acts as a support for the RSI.

- Bearish Market: When the RSI consistently stays below 60 and often drops below 40, it indicates a bearish market. The 60 level acts as a resistance for the RSI.

Usage:

- Entry Points:

- Bullish Market: Enter long positions when the RSI bounces off the 40 level.

- Bearish Market: Enter short positions when the RSI falls from the 60 level.

- Exit Points:

- Bullish Market: Consider exiting long positions if the RSI falls below 40.

- Bearish Market: Consider exiting short positions if the RSI rises above 60.

Range Shift Concept (20-60 and 40-80)

The range shift concept involves using broader RSI ranges to identify the strength and sustainability of a trend. The ranges of 20-60 and 40-80 are used to detect deeper bullish or bearish market conditions.

20-60 Range:

- Bearish Dominance: When the RSI fluctuates predominantly between 20 and 60, it suggests a strong bearish trend. The 60 level acts as a cap, and the 20 level indicates oversold conditions.

- Signals:

- Enter short positions when the RSI falls from near 60.

- Watch for potential reversals or consolidation if the RSI drops near 20.

40-80 Range:

- Bullish Dominance: When the RSI fluctuates predominantly between 40 and 80, it suggests a strong bullish trend. The 40 level acts as a floor, and the 80 level indicates overbought conditions.

- Signals:

- Enter long positions when the RSI rises from near 40.

- Watch for potential reversals or consolidation if the RSI approaches 80.

Practical Application

Example Scenario:

Consider a stock currently trading with the following RSI patterns over a few months:

1. RSI 40-60 Range:

- The stock's RSI consistently stays above 40 and peaks around 60-65. This suggests a moderate bullish trend.

- Trade: Enter long positions when RSI bounces off 40, expecting the bullish trend to continue.

Live Chart

2. RSI 20-60 Range:

- The stock's RSI frequently drops near 20 and struggles to rise above 60. This indicates a strong bearish trend.

- Trade: Enter short positions when RSI falls from near 60, targeting further downward movement.

Live Chart

3. RSI 40-80 Range:

- The stock's RSI often stays above 40 and reaches 75-80, suggesting a strong bullish trend.

- Trade: Enter long positions when RSI rises from near 40, expecting the bullish momentum to sustain.

Live Chart

Visualization Example:

Imagine we plot the RSI for a stock over a period:

```

Price: 90 85 80 75 70 75 80 85 90 95

RSI: 50 45 40 35 30 40 50 55 60 65

Range: 40--------------------60

Price: 95 90 85 80 75 70 65 60 55 50

RSI: 65 60 55 50 45 40 35 30 25 20

Range: 20--------------------60

Price: 50 55 60 65 70 75 80 85 90 95

RSI: 40 45 50 55 60 65 70 75 80 85

Range: 40--------------------80

```

Conclusion

The Relative Strength Index (RSI) is a versatile and widely used technical indicator that offers valuable insights into market momentum and potential reversal points. By grasping its calculation, interpretation, and practical applications, traders and analysts can effectively integrate RSI into their trading strategies to enhance their decision-making processes.

Backtesting results indicate that when applied correctly, RSI can contribute to a profitable trading strategy. However, its effectiveness is maximized when combined with other tools and proper risk management practices.

The RSI 40-60 concept and the range shift concepts (20-60 and 40-80) provide advanced methods for interpreting market trends and momentum. By understanding and applying these concepts, traders can make more informed decisions, improving their ability to capitalize on market movements. These techniques, particularly when used alongside other indicators and sound risk management practices, can significantly enhance trading strategies.

For those seeking automation and live tools, this feature is available on TradingView.

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