The Relative Strength is not an Overbought/Oversold Indicator
The Relative Strength is not an Overbought/Oversold Indicator
Cho Sing Kum
30th Dec 2002
For many people the very reason they learn Technical Analysis is the blind obsession of only wanting to know when to buy buy buy and when to sell sell sell. Nothing else is important to them. This group of people, they will fail repeatedly. For with this blindness, this ignorance, they will never be bothered to understand the mathematics, what they measure, how they behave, basically the original intention and interpretation of the indicators.
The Relative Strength Index is never an overbought/oversold indicator. If you did not learn Relative Strength Index from the original text, then it is very likely that you have been taught the wrong thing right from the beginning – that RSI is an overbought/oversold indicator. I want to tell you straight away that this is wrong.
The problem with the human mind is that the first time we hear about something, the first time we read about something, to our mind this is the truth about that something. Any subsequent thing they hear or read about it we would discard them as false. This is a mental problem. You may disagree but to me anything that has the source of the problem traced to the mind, to me this is a mental problem.
I quote from the second last paragraph of Section VI of the book New Concepts in Technical Trading Systems by J. Willes Wilder Jr. The words in bold are the way they were printed in the book. Do note the three words very carefully.
"(5) Divergence: Although divergence does not occur at every turning point, it does occur at most significant turning points. When divergence begins to show up after a good directional move, this is a very strong indication that a turning point is near. Divergence is the single most indicative characteristic of the Relative Strength Index. Note that the top made on November 9 [1977 of the Jun78 Silver futures contract] was indicated by an RSI value above 70 and divergence. It was confirmed by the failure swing, breaking out of the pennant formation and breaking the support line."
What is failure swing? I quote from Wilder’s book again. The scan images of the actual illustrations from the book are below. They are Fig 6.3 and Fig 6.4 as in the book.
“(3) Failure Swings: Failure swings above 70 or below 30 are very strong indications of a market reversal. (See Fig. 6.3 and Fig. 6.4)”
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[...] that plunge that the RSI is below 50 and near 25-30 that is at over sold level. The better way to use RSI is to use it to find the divergences from the price [...]