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CATEGORY Technical analysis

What Relative Strength Tells You At Any Time



December 11, 2017

One of the best ways to find opportunity is by spotting excessive fear and greed.

But that’s easier said than done. Or so we think.

While none of us have a crystal ball, or hold the Holy Grail to trading secrets, you can give yourself an edge by simply paying attention to what herd mentality is telling you.

Of the hundreds of technical setups we can use to gauge momentum, relative strength (RSI) is one of the most powerful tools to pay attention to when you want to find opportunity. RSI is a momentum oscillator that measures the speed and change of price movements of a stock. The closer RSI gets to its 30-line, the more oversold the stock is considered to be. The closer RSI gets to its 70-line, the more overbought the stock is considered to be. 

Take a look at Disney Co. (DIS) for example.

 

Notice what happens when RSI gets to or above the 70-line.  DIS begins to peak and turn lower.  Now, notice what happens when RSI gets to or below its 30-line.  DIS begins to find support and pivot higher. Of course, as we’ll often tell you, confirmation of potential trend change is always essential. Confirm with MACD, Williams’ %R and Bollinger Bands, too for example. Just don’t buy because RSI is at the 30-line.

Look at the excessive fear in DIS in late September 2017. 

Who would touch that?  Only a fool, right? 

As it turns out, it was one of the best times to buy.

RSI was deep under 30.  MACD pulled back too far too soon.  Williams’ %R was deep under 80, oversold.  Once we got positive confirmation in the days that followed with a build of momentum, it became a good time to buy. 

Sure, you may say, “Any one can say that after the fact.”

And sure, we could do that.  But that’s not what we’re doing. Look at what happens each time DIS pulls back with confirming oversold indications. The reversal higher isn’t immediate. It takes a few days.  By being in the know, you can do well.

Again, though, confirmation is key.

Or, look at what happens to Disney when RSI moves to or above its 70-line with an overextension on MACD and Williams’ %R above 20. The stock reverses, as it did at the start of August 2017 and the start of May 2017.

Even if you don’t subscribe to the idea that technical analysis works, history proves otherwise.


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