[Music] In today's episode, we're going to talk about the Relative Strength Index and how you can use RSI in your trades to help you get better at predicting reversals.

This is a well-established trading strategy that can help increase your accuracy by only trading reversals when you see both the candlestick pattern and the RSI align.

This is where an indicator helps confirm or deny what you think is going to happen. Now I'm going to take it a step further and introduce the combination of RSI and Bollinger Bands on reversals.

So let's go ahead and jump into the chart.

Here, what we're looking at initially is a candlestick chart for a stock that I happened to trade just a few days ago.

Now, you can apply this strategy and these indicators I'm going to share with you whether you're trading stocks like I am or you're trading futures, Forex, cryptocurrency; it doesn't matter because this is, again, part of the universal language of the financial markets.

So what we have here on my chart initially are very few indicators. This is a five-minute time frame on the left and this is a one-minute time frame on the right.

These are both for the same stock, and this is something that I very commonly do when I'm trading. I have the five minutes so I can kind of be zoomed out, and then I have the one minute so I can be really zoomed in on the current candle.

The indicators that I have on here include the nine-period moving average right here in gray, the 20-period exponential moving average, and the 200 period exponential moving average.

You'll see those on both time frames. The orange line is the volume-weighted average price, and down below we have volume bars on In the one minute chart, we have the MACD, and on both time frames down below, you can see the RSI.

The RSI is plotted with this purple line, and it has an upper limit, a middle limit, and a lower limit. Now, the upper limit is at 70, the lower limit is at 30, and the middle is at 50%.

Now, RSI is an oscillator, which means it oscillates between a range of 100 at the top and 0 at the bottom.

Although it is, at times, possible to see something go above or below, it's pretty rare. So, 99% of the time, the RSI is going between 0 and 100.

If the relative strength is 100, on one hand, you have something that is incredibly strong, but on the other hand, it can't get really any stronger.

What that means is that more likely than not, at some point pretty soon, we're going to see a correction.

If we're all the way up at 100, a correction even down to just the midpoint of 50% here would be a very sizable correction, most likely in price.

Inversely, if the RSI was way down here at 0 or 1, that tells us that the price has been incredibly weak and could remain weak for a bit longer, especially if there's bad news.

But when it reverses, it again has lots of room to reverse back up, and that's when we can see a big swing in price.

So, if we focus on using this to time reversals, the areas that we're going to be interested in are when we're near extremes, and that's why we have these limits at 30.

and at 70, so above 70 or below 30 is when we're going to be at more extreme ranges, and we really only want to consider reversals in these areas.

So if the RSI, just for instance, is kind of oscillating like this, this is not in the pink here or purple; this is not an extreme enough range, and most likely trying to time reversals here we're not going to get enough volatility to make a profit.

As you probably already know, as an active trader, we need volatility, but of course we need to manage risk, and our job is to try to make an accurate prediction about what the price is going to do next.

So we don't want to get in and just have very small moves; we'll lose money on the spread and on slippage.

We need to see sizable moves, and so only focusing on trading reversals when the RSI is up at these extreme levels can help with that strategy.

However, we can also use this when we're trading momentum.

So, in terms of these indicators, both on the one-minute and the five-minute time frames, I have them set the exact same way.

So this is a 14-length period using the SMA 14 period here, and the style has these upper and lower limits, and then the one in the middle; this is the standard RSI setting that most traders will use and is default when you add RSI to your charts.

I'm a big fan of using indicators in their default settings because I want to make sure that I'm viewing the market in more or less the same way that 90% of other active traders are viewing it.

The reason is that the signals, when they're seen by more people, will be responded to accordingly. So if everyone's seeing a red light, then everyone's going to stop.

If everyone's seeing a green light, everyone's going to go more or less. So being one of the first to see the red light or green light, or to predict it, will come with intuition, and that is the result of experience. But ultimately, I want to use standard indicator settings.

I'm using the same settings on my MacBook, on the one-minute chart. Now, I'm primarily a one-minute trader, so I usually use my indicators on the one-minute chart more closely than on the five-minute. But if you're primarily a five-minute trader, or a fifteen-minute trader, or a daily trader, you want to use your indicators on that time frame.

Okay, so we're going to start by looking at this momentum stock. This is a stock that went up 100% in just a few hours. This is really some impressive price action. So if we look at this on both the one-minute and the five-minute charts, I'll zoom out the one-minute just a little bit more.

Let's take note of things that we see on the RSI, especially.

So first, the move begins here after hours, and as the stock squeezes from 4 to 4.50 up to 5, you notice that the RSI goes all the way up here to a peak of, let's see, it's just about 87.

It really gets super extended right up here, uh, 83.

Sorry, it goes up to 83, so we're certainly well above our upper limit. However, we know that we only stay at these upper limits for a limited time.

limits for a limited period of time and this ends up dropping back down and coming back up right here. Now, I find this really interesting, so let's actually zoom in to this, um, this first beginning of the move right here.

Some traders might have looked at this as an opportunity to buy right up here at 550, which was this candle here.

You might have thought, well, look, we've just had this big move up, we've pulled back, and now we're coming back up to break through this level.

Now, I'll note a couple of different things that make me think twice about this setup, but focusing first on RSI, we have the RSI that moved up and now the RSI is moving down, which means you actually have a divergence because the RSI is moving down here while the price moves back up.

Whenever that happens, I pay extra close attention and I take the signal from the RSI that this is more likely to be a false breakout.

The second indicator that is helping to reaffirm that position is the fact that the MACD, the Moving Average Convergence Divergence indicator, has crossed over right here at this line.

I usually focus on trading the front side of the move before the MACD crosses over, and once it crosses over, I'm very hesitant to take these, uh, second attempts for a move higher.

Now, from a, um, a charting perspective, this is showing a double top. A double top is created when you have a move higher and a pullback that's a little bigger than you would like to see.

This is a bigger pullback than we would like to see, and it's noted by the fact that we broke below the nine-period moving average and we came all the way down to the 20, so it's a steeper pullback.

As a result of the steeper pullback, the MACD crosses over because the moving averages are converging.

MACD is the Moving Average Convergence Divergence indicator, so the MACD is converging. The moving averages are converging.

RSI is trending down, and that's a divergence from the price moving back higher. This is a highlight of being a false breakout here at this double top.

This is a no trade. Now, if you did not look at either of these indicators, we'll just hide it for a second.

You only looked at the chart; the only thing you would have to go on is the fact that this is a possible double top.

But we did pull up here; we did sort of a little micro pullback, which could almost be viewed as a cup and handle formation.

And clearly, there was some volume here. There were some people that bought into that breakout, but it didn't end up working, and I think the result, um, on this is because the pullback was a little bit too steep.

And when you have a steeper pullback, that's when you're going to have the MACD crossover, and the RSI is going to pull down.

Those indicators should have helped keep you out of this trade.

Okay, so then we pull back; the RSI dips back down. Here we go to a low of about 35, so we do come pretty low, but not low enough that this would trigger a purchase based on the RSI being in the oversold territory.

The price then comes back up to 550 here, as you can see, and right in this area, we now see that the RSI is stair-stepping up, right?

Little pullback, stair-stepping up. The MACD has crossed back over into the positive, right?

Here, so at this point, we now have a green light. This actually looks okay and acceptable for a trade right here at 550, so we back this up, right?

At this moment, you would look at this and you might think, well, I don't know, look, it did this false breakout right here. But remember, right there we were getting a divergence in the MACD and the RSI, and we were having a negative MACD because we had this big pullback.

Now we've pulled back, and we've had the opportunity to reset, and we're starting to pull away. So this is a spot right here where the MACD is a check yes and the RSI is a check yes.

It's okay that the RSI is near the overbought area because it's trending up.

We're not looking for—I mean, so number one, this is not a reversal pattern on the chart. It's not extended enough to be a reversal.

This is a pattern that is a flat top breakout pattern for a break of resistance. And so let's fast forward. So what we get here is this break through 550 all the way up to 650 right here, up to about 624, which is still a really nice move.

We then pull back just a little bit, and then into the next pre-market session, we push higher.

Now this starts to get a little interesting because right here notice now we're starting to see a divergence again, and that was caused by this initial candle that dropped down.

Now the MACD dipped below for a second but is back in positive.

However, the RSI, as the price makes a new high right here, does not make a new high.

new high and that's what I pay close attention to when price is making new highs but the RSI is not; we're having a divergence that indicates more likely than not the price is not going to sustain this level.

Now this is a spot where you could consider a reversal trade because the RSI is above and we're having this divergence.

So now we get a pullback here, we dip back down, we start to go sideways and right here, watch this, the MACD crosses over.

So now we have a MACD crossover, the RSI is starting to stair step back up.

We pull back a little bit, so right now another diver—well actually we're not really in a divergence, we're pretty well matched here.

Now one thing that I'll say is I don't typically like to take trades below the volume weighted average price, so although we have a crossover here, I'm typically not going to take that trade unless the price is a little higher.

So we're going sideways, we're going sideways and then, yeah, right here we end up getting a surge of momentum.

Now this surge of momentum was right at 7:00 a.m. and you can see all of a sudden a ton of volume came in.

So that's because 7:00 a.m. is when a lot of retail brokers come online. So what ends up happening is you get a massive boost of volume, price surges up and immediately the RSI goes into the over bought territory.

Okay, so now we hit this big peak here and this is where some people are going to start looking for a reversal.

The RSI is extended, the price is extended, we don't have a divergence but we have it right here.

Right here we have a divergence: the price goes higher, but the RSI does not go higher. So this is now an indicator that we're still in the overbought territory.

This is a spot to watch for a short. If the price was really strong, first of all, it wouldn't have pulled back as much as it did right here, causing the MACD to start to converge and beginning to cause the RSI to dip.

So we get this sort of push higher, but we stall out.

The RSI shows it's making a lower high, and now you get this sort of slower flat, and then unwind.

It's just not able to push higher. Now, in my own trading, I find that using RSI to help me time entries to the long side for momentum is not particularly helpful.

I find MACD is more than enough for my trading. However, when I am trading unaligned, which is a strategy I focused on as a beginner, I really liked RSI and I really liked Bollinger Bands.

So now let's pull up one of the scans that I've developed here, which is the RSI Trend.

This RSI Trend scanner is actually searching the whole market for stocks that have the highest and lowest RSIs in the whole market.

Okay, so what's the idea behind this scan? I'm trying to search for these extremes. I'm searching for these data points right here.

Now we know that we can search for a stock that has a 99 or 100 RSI or a 0 RSI.

If we find it, we know that the stock is currently in this extreme area right here, so it may be worth considering a trade.

Now, it's not a guarantee that this is going to give us an opportunity because there can be stocks that have a 100 RSI but they have no volume and they're not liquid.

So this stock, for instance, let's just look at the top one.

Okay, so this for instance has a 100 RSI. All right, so this is based on the 15-minute chart; it's very extended. The price has just been moving higher and higher, but the volume is a little light at 1.3 million shares.

We may not at this current moment see an opportunity.

So let's go ahead and add one more indicator here; we're going to add the Bollinger Bands. All right, so Bollinger Bands we're popping them on, and what we're going to look for are spots where the price is outside the top Bollinger Band and the RSI is extremely extended.

Because the price being outside the Bollinger Bands indicates extreme price action. For those that aren't familiar with how Bollinger Bands work, they create a band around the current price, so you can see it's sort of this channel here.

The blue lines are the top and the bottom, so it creates this channel.

Ninety-nine percent of price action occurs within the channel of the Bollinger Bands. However, in the unusual case that the price is outside the Bollinger Bands, as it is here, it almost always leads to at least a short-term correction back within the Bollinger Bands.

So let's see, um, we'll just scan through some of these charts here, um, and see what we find.

Okay, so CVS is another one, and you'll notice that these charts are actually, um, between these two were somewhat similar, which is common and more likely that this ties in with overall market strength.

The Ultimate Relative Strength Index (RSI) Trading Strategy

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The Ultimate Relative Strength Index (RSI) Trading Strategy

The Ultimate Relative Strength Index (RSI) Trading Strategy

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