Volume Speaks: Unlocking the Secrets of On Balance Volume (OBV)

If you have read any of my articles on indicators, you know by now that I point out over and over again that you should not take any trading decisions on indicators alone. It’s in the name; indicators indicate. That is all they do. So far, I have written about indicators that is calculated on price only; the simple and exponential moving averages, the RSI and the MACD. But volume is a very important variable in trading which these indicators ignore.

There are several indicators that take volume into account and the On Balance Volume, or OBV, is one of them. It was invented by Joseph Grenville and introduced to the public in this book "Granville's New Key to Stock Market Profits" in 1963. He had the idea that volume precedes price movement and by tracking cumulative volume it would be possible to anticipate a change in price.

Volume is definitely important to traders, but can it really predict the future? In this article I will show you how to calculate the OBV and how to interpret it and of course, give you my personal opinion. At the end of the article you will find links to additional sources on the OBV.

What is On Balance Volume (OBV)?

It is a momentum indicator that uses volume flow to predict changes in stock prices. It is based on the idea that volume is a leading indicator of price movement. By observing the direction and magnitude of volume flow, traders can get a hint of the strength or weakness of a price trend.

In short, the OBV measures the volume of days the market goes and when the market goes down and compares the two. OBV is then graphed as a single line, usually below the price chart.

How to Calculate the OBV

The calculation of OBV is straightforward. You simply add up the volume on days when the closing price increases and subtracting the volume on days when the closing price decreases.

If today's closing price is higher than yesterday's closing price, today's OBV = Yesterday's OBV + Today's Volume.

If today's closing price is lower than yesterday's closing price, today's OBV = Yesterday's OBV - Today's Volume.

If today's closing price is equal to yesterday's closing price, today's OBV remains unchanged from yesterday's OBV.

OBV is a cumulative measure, meaning it builds on previous values, giving a running total that reflects the net buying or selling pressure over time.

Just like some other indicators, like the Exponential Moving Averages, we need a value of OBV to calculate the OBV. For the first calculation we don’t have that value. We need a starting point and that is normally set to zero. Here is an example of the calculation of OBV:

Interpretation of OBV

OBV is used to confirm trends and find divergencies. When both price and the OBV are making higher highs and higher lows, the stock is considered to be in a solid uptrend. When they are both making lower lows and lower highs, the downtrend is confirmed.

When they go in different directions there is a divergence. If price goes up but the OBV is starting to go down, there is a negative divergence and we should be alert that a change in the price trend is possible. And of course, if the roles are reversed and we have a positive divergence, that is, price goes down, but the OBV starts to go up then we have a positive divergence.

In my opinion, a divergence in the OBV doesn’t have to mean that OBV and price goes in opposite direction. Price can continue up while OBV goes flat is an indication that volume isn’t increasing and below you will find a example of that in Apple.

It can also be used to confirm breakouts. When the price breaks out of a resistance level, an increasing OBV can confirm the breakout, indicating strong buying pressure. If the price breaks down below a support level, a decreasing OBV can confirm the breakdown, indicating strong selling pressure.

The idea behind this is that volume precedes price. A significant movement in OBV without a corresponding move in price could indicate that a price change is imminent. That makes sense to me since increasing volume is more or less necessary for a stock to go up. But as with any indicator that is designed to find divergencies; a divergence can exist for a long time before there is and actual change in trend.

OBV wasn’t the first indicator to take volume into account. The Accumulation/Distribution Line (A/D) is older and Charles Dow, the founder of Dow Theory, believes that volume was very important in confirming price trends but never developed an indicator. But the OBV was the first indicator to be available to the public. Before OBV, volume analysis was largely subjective. Granville’s work brought a scientific approach to volume analysis which has been built upon, and today we have other indicators that take volume into account. More about them in later articles.

Limitations of OBV

The advantage of OBV is obvious; it takes the very important volume into account. But that doesn’t mean that it is the holy grail (there isn’t one in case you were wondering).

Like any technical indicator, OBV can generate false signals, for instance, during periods of low volume. It is also sensitive to volume spikes. If there is a day of extremely high volume due to some unforeseen event it has a big impact on the calculation but might not have anything to do with the strength of the trend itself.

Also like many indicators, during time of consolidation in a sideway trading range, the usefulness of the OBV is limited at best.

Use of OBV in Practice

To illustrate the practical application of OBV, let’s examine a few real-world examples:

Advanced Micro Devices (AMD)

AMD started a nice rally in November 2023 that continued in to March 2024 and price went up about 145% from bottom to top. As we can se from the chart, the top in OBV set in late January when the stock went into a short consolidation. When the stock made new highs in March, the OBV did not and that was a very clear negative divergence.

Apple (AAPL)

In late 2020, Apple’s stock price was rising steadily. However, towards the end of the year, OBV began to diverge negatively from the price, signalling that the buying pressure was waning. Subsequently, the stock price corrected in early 2021, validating the OBV signal.

Snap (Snap)

In late September 2023 price bottomed out while the OBV had already started to rise from late August. Later in the year price started to go sideways while the OBV declined before price made a huge down gap in February.

Advanced Uses of OBV

A volume indicator like OBV is commonly used together with another indicator as part of finding good trading setups.

A great example of this is to combine OBV with Bollinger Bands. This can help in identifying overbought or oversold conditions. If OBV reaches the upper band, it could indicate that the stock is overbought and a short term correction might be in the cards. If OBV reaches the lower band, it could indicate that the stock is oversold and a we should look for a possible rebound.

Since OBV is not an oscillator (meaning that is oscillates between fixed high and low values), it cannot find overbought and oversold conditions on its own, like for example the RSI which oscillates between 0 and 100.

Another way is to combine OBV with moving averages. Plotting a moving average on OBV can help smooth out the data and provide clearer signals, but the signals will be slower. A crossover of OBV above its moving average can signal a buying opportunity, while a crossover below can signal a selling opportunity.

Final Thoughts

Volume is an extremely important variable in trading. In fact, volume is an indicator of itself. It takes volume to move the market (upwards anyway). If there are more buyers coming into the market they push the price up. It is a simple matter of supply and demand. If there are more buyers than sellers, then prices will go up and if there are more sellers than buyers then prices will fall.

To have an indicator that helps us identify volume in a meaningful way, is a very useful tool for a trader to have in his or her toolbox. The OBV tracks volume over time and is good at confirming trends and indicate possible changes in trend.

The problem I have with OBV is that it treats all price action equally. Volume is added or subtracted in the calculation no matter what the trading day looked like. But that is not very accurate in my opinion (and many other’s opinions to) since a day with a close at the high, or very close to the high is more bullish than with a close near the lows, even if they are both closing higher than the previous day. The OBV treats them equally.

In this example both days are treated equally by the OBV but they are clearly very different in nature.

Also, I don’t think that OBV give that many signals in the form of divergencies, and they can also be very weak. In the cases above the divergences on the OBV line is fairy flat. Adding a moving average to the OBV may cut out some noise but it will also make the divergences even more difficult to see. On the MACD indicator the divergencies are much more obvious.

As always, don’t just take my word for granted. These are my thoughts and experiences with the OBV. Others might disagree. Here are some other resources you might find interesting. I can especially recommend the video from the Darwinex YouTube channel. There are plenty of great videos on this channel so it is worth checking out.

Worth pointing out that I may not agree with the sources below 100%. For example, the Investopedia article states that the OBV is a leading indicator since it predicts the future. I totally disagree with this and you can read about that in this article.

On-Balance Volume (OBV): Definition, Formula, and Uses As Indicator - Investopedia

On-Balance Volume - Wikipedia

SMA vs. EMA: Understanding and Using Moving Averages for Trading Success

The Moving average is probably the most common used indicator in the trading world. It is easy to understand and to calculate and therefore a good indicator to begin with. Most traders put it on their charts without thinking about it. I think that is a mistake, you should understand everything that is on your chart, or it shouldn’t be there.

In this article I will show how to calculate and use the Simple Moving Average (SMA) and the Exponential Moving Average (EMA). They are similar but not equal.

Difference Between the SMA and the EMA

The SMA is equally weighted, every price value has the same impact on the average. That is not so for the EMA, where more weight is given to the more recent and less to the older price data. That is why the EMA is called a weighted moving average.

This makes the EMA more responsive to changes in price while the SMA is slower to react. In turn this makes the SMA line smoother. Both have their advantages and disadvantages as we will get to later.

Calculating the Simple Moving Average (SMA)

This is probably the easiest calculation you will find in finance. You simply take the average for the past n days and then move the average as they days go by. If we want to calculate a three day moving average in Excel it would look like this:

 

Calculating the Exponential Moving Average (EMA)

This is not as straight forward as calculating the SMA. The formula for calculating the EMA is:

With the boring math formula out of the way, we can get on to the actual calculation. But you may have noticed something: in the formula, EMA is used to calculate the EMA! How can we plug in a value of the EMA into the formula when we are trying to calculate the EMA?

Well, we can’t, so we have two options. For the very first calculation, we can either calculate the SMA of the previous n values or simply use the very first price value. It really doesn’t matter since, when we move the average along when we get the next price, this made up EMA is no longer used. Also, since it is a weighted average, the first instance has the least impact.

Calculating the three day EMA in Excel, using the SMA as the first “EMA value”, looks like this.

Note how the first calculation in cell D7 is different since it uses the SMA. The smoothing factor is calculated in cell D2.

That is about as much as I want to dive into the calculations. If you really want to explore the mathematics of moving averages, then Wikipedia has all you need. Links at the end of the article.

How to Use Moving Averages in Trading

Moving averages are used to define trends, both long term and short term trends. Since the EMA is more responsive to changes in price, it is generally more used by short term traders, while the SMA, which is smoother is used by longer term traders and investors. But that is a generalisation, either can be used for both long and short term. I use only EMA since I only trade in the short term.

Strategies using moving averages mostly involves “crossovers” of some kind. That could either be when a faster moving average crosses a slower moving average. Or when price crosses a moving average.

A fast moving average is one with fewer days in the calculation. A moving average using 10 days is more responsive to changes in price, or “faster”, than a 50 day moving average.

Example of a Crossover Strategy in FedEx

Entry: EMA10 crosses up above EMA20.
Exit: EMA10 crosses down below EMA20.

Here the yellow EMA10 crosses line cross above the blue EMA20 line and the trade is opened. When it crosses down below the EMA20 again, the position is closed. This was a profitable trade but not a great one. There is plenty of lost profits since it took a while for the EMA10 to cross down below again. If we had used SMA10 and 20 it would have taken even longer for them to cross, and the profit would have been even smaller.

Towards the end of the chart there is another crossover when the price gaps up on positive news. You would think that it would have been a wonderful trade, but it would not. It is a little difficult to see, but what makes the EMA10 cross above is the strong move up. So it would not have been possible to enter the trade at the $255 level.

There are other strategies however that would have entered the trade at $255-ish. But that is for another article. Trading based only on SMA or EMA crossover is not something that works in the long run. There are too many “false” signals when the market isn’t in a clear up or downtrend.

Which Moving Average is Best?

Okey, we have to ways of smoothing the price data, but which is better? Which one should you use? The short answer is that it doesn’t matter since they differ very little. Take a look at this chart of Dell with both the SMA10 and the EMA10 plotted.

The EMA10 is the yellow line and the SMA10 the purple. When the market gaps down, the EMA10 reacts much faster since it gives the most emphasis to the last day of the 10-day calculation. The equally weighted SMA10 is much smoother.

At the beginning of the chart, when the market is in a clear uptrend, there is little or no difference between the two. Is the faster EMA better since it is more responsive? Not necessarily, it is all up to you hand how you trade the markets that matter. The advantage with the slower SMA is that it cuts out a little more market noise than the EMA.

Final Thoughts

I use the EMA since I think it makes sense to give less weight to older values. The further back in time we go the less importance those value should have on smoothing the data and find trends. I also like the fact that it reacts quickly to price changes, that just suits my style of trading. The downside is that it doesn’t cut out as much noise as the SMA.

But in all honesty, I don’t think it matter which one you use as long as you pick one of them and stick to it. Even for short term trading the SMA would work just as fine. And the EMA for longer term trading as well.

A trading strategy based only on moving average will not work in the long run. It will do fine when the market goes from a period of sideways movement into a trend, but when the market is in that sideways trading range, there will be too many false signals as the averages will cross each other several times.

Moving averages can be very useful together with other indicators, price and volume. It is also common to scan for these crossovers on the various trading platforms to alert of possible trades. When you have your list of crossovers, you do in and check them one by one.

Finally, a word of warning. There are an endless number of finance influencers on YouTube trying to “sell” moving average crossover strategies with claims like; “99% accuracy” or “the secret strategy they don’t want you to know about”. These people are all scammers.

DON’T EVER apply a strategy you have seen you YouTube or read about here on Medium, and that includes any strategies of my own, if I ever decide to reveal one. You must always understand the logic behind a strategy and test it thoroughly before implementing it in the market with your own hard earned money.

Links

• Moving Averages on Wikipedia
• This article is also published on Medium

Trade Examples using the MACD

I use MACD to find trends that might come to an end. That is, I look for diversions, both bullish and bearish. I don’t look for crossovers much, nor do I use the histogram. The settings I use are the traditional 12, 26 and 9. I haven’t actually experienced in changing them since I think they work just fine for my trading style.

Of course, I don’t make trade decisions based on the MACD. It is only an indicator that a change in trend is possible and that the stock in question is worth putting on the watchlist. And that’s an important point to make; just because there are signs a trend is about to end doesn't mean that it will turn on a penny and trend in the other direction.

So the method of operation is:

1. Look for the divergence in the MACD v Price.

2. Look for an entry signal on the Price chart.

Here are a few examples of trades I have taken after identifying a divergence. Some worked out better than others. Some I sold too soon. Some I should have added to as the trade went along.

Citigroup

Citigroup MACD trade

In early September 2023, I noticed that there was a small divergence starting to build in CITI. Shortly after, there was surge in price and a possible entry point (the orange arrow), an entry point I didn’t take. The reason being that I didn’t think that the divergence had been going on for lone enough. If I had had a shorter time frame in mind for my trade (1-3 days) this could have been a good entry.

As it turned out, it was the right decision, and the stock continued to fall. The divergence continued, however, and when we had some gap ups and a crossover of the signal and MACD lines, I took the trade (the first green arrow). I got in at the end of the day and at the very top of the day.

My stop was just below the low of the day of entry, at just a potential loss of 3%. That is actually a little tight but if the price starts to move into the gap, it usually goes all the way. But I had made the right call and the stock gapped up again the next day and I immediately moved my stop to break even (all the little red lines are my stop levels).

After a few days of sideway motion it gapped up again, moved into a new consolidation, and when it broke out of that one, I added to the position. As CITI continued to rise, I kept moving my stop up and was almost stopped out twice, the price was just a few cents from my stop level.

Eventually, I was stopped out at $25.89. In the short term that was a good stop out but in the longer term not so good as price continued to rise. But overall, a very well executed trade. In hindsight, I could have added to the position several times, but everything is easy with hindsight.

3M

3M MACD  trade

Divergence in October and when it broke the green resistance line I took the trade. This time I put my stop at the EMA20 which held until January, and I was stopped out just in time before the gap down. I was almost stopped out earlier in December as the price came down to EMA20.

Using a moving average like this take out a lot of the “should I or shouldn’t I move the stop” type of thinking. This is not an article about stops though, but it sure makes life simpler than raising stops with regards to price levels or patterns.

Autodesk

Autodesk MACD trade

Divergence from late April and a gap up and huge up day, right up to resistance level. Then it was fairly volatile for a while before break out of resistance and I took the trade. Since it was so volatile I decided not to risk very much so I put my stop just below the breakout level.

Then it move very strongly and I moved my stop to the second red line. Then another strong move and here it looked really good and I was hoping for a test of $265-$270. But that never happened, instead it fell sharply and took me out just under $240.

VF Corp

VF Corp MACD trade

A very “sharp” or steep divergence in April – June and when the price gapped up above the falling trendline I went long with a stop just inside the falling trendline. It consolidated a few days then moved up again and I raised my stop.

Then I was take out on an intraday dip only to see the stock move higher again. But that’s how it is sometimes; or, a lot of times. After I was out of the trade the stock has been both lower and higher, breaking the EMA’s so I would have been out even if I had used other stop strategies.

The MACD doesn’t catch everything though. Here are some examples of recent trend reversals that it missed, and as a consequence, so did I. I didn’t take any of these potential trades.

Uber

Uber no signal in MACD

Uber nearly doubled from November 2023 to February 2024. There was no divergence in the MACD. A great entry would have been when price crossed the green falling trendline.

Super Micro Computer

Super Micro Computer no signal in the MACD

From January 2024 to early March, SMCI rose over 300%. Unfortunately, there was no divergence in the MACD, so this is another one that I missed out on.

Final Thoughts

I think the MACD can give great signals of changes in major trends. When a stock goes from one clear trend to another, it usually gives you a good signal. But it does miss as well as we have seen, and the really good signals are few and far between.

My feeling is that the bull signals are better than the bear signals. But this is just a hunch, I cannot back this up with data.

When a stock is moving sideways the MACD will also move sideways and crisscross around the zero line. If you traded crossovers of either the MACD and Signal lines or the zero line, you would quickly be whipped out in a market like this.

I know I rant about this all the time, but you must make entry and exit decisions based on price and volume, not on an indicator. Use indicators to find possible trades and use price to take the trades.

If you want to know more about the MACD indicator, I have and article om Medium which you can find here.

Learn to Love the Daily Grind

There are many traits I think a trader should have if he or she wants to be successful. One of them is the ability to put in the hours. If you can sit down, cut out all disturbing noise, and just focus on what you are supposed to do, then you have one of the most important traits. If you are one of those who not only can do it but love to do it, then I see no reason why you should not become a master trader.

When you read about successful traders, you will quickly notice that they share many traits, and hard work is one of them. Sitting down and going over chart after chart is actually fun work. Sometimes I hope that the weather over the weekend will be horrible so that I have an excuse to sit at home and study my charts.

Trading and technical analysis can be very addictive. It’s like golf; once you are hooked, you are in it for life. But to get there, it is important to understand that trading is for those who love hard work. Trading is not for the lazy. Trading is not a get-rich-quick scheme; it’s a slow grind that, over time and with many setbacks along the way, can make you financially independent. Unfortunately, many people don’t understand this.

I don’t know why, but for some reason, some people seem to think that trading is a game that you take lightly. There is no end to videos and articles about how to make money in a very short time with little work. “How I make $500 per day with just 15 minutes of work,” “Trade for an hour a day, make $1000,” or “I made a trading bot that makes $100,000 per month.”

Scammer on Twitter

I don’t know how many of the writers and video makers who produce this kind of content actually believe it. I just hope that you don’t believe it. In my eyes, these people are all fakes and are only interested in clicks and/or want to sell you a course or a bot. Please don’t fall for this.

Don’t ever buy a bot and let it loose in the market with your money. You don’t need to buy a course from a YouTuber; all the information you need to make it in trading is already out there. FOR FREE. Spend your money on books. There are a few classics that I list at the end of this article.

You can be a trader in a few minutes if you want. All you have to do is open an account with a broker, fund it, and start trading. You need no license, formal training, or diploma. If you want to be a successful trader, however, you must do the work. And a lot of it.

Jesse Livermore talks about this in “How to Trade in Stocks” and “Reminiscences of a Stock Operator.” People used to ask him how to pick a winner in the stock market or “Just tell me what stock to buy.” He compared it to someone asking a doctor who has spent years training and perfecting his profession how to perform surgery.

I get this also. “Just tell me how to spot a winner,” and that is usually all they want to know. They want to know how to identify a stock that will go up, or as we say in the trade, how to find an entry signal. When I begin to explain that there is much more to it than just finding entry signals and that risk management is really what they should focus on, they interrupt me. “No, no, I just need to know what to buy, and I’ll be fine.”

They couldn’t be more wrong. They will not be fine because they are not going to do the work required to be successful. I know that because if they are not even willing to listen to what I have to say for two minutes, they are not going to sit alone in a dark room looking at charts for hours upon hours, year after year.

They don’t want to hear about when to sell after a stock has gone up. They don’t want to know how to cut losses. Mention risk management, and they will interrupt you, bringing up the what-to-buy question again. Position sizing? Forget it!

I will write about specific entries, stops, exits, position sizing, journaling, and all other practical things in later articles, but until you understand that, as a newbie, you have a ton of work ahead of you, those things will not help you.

If you want to make it as a trader, then don’t be like these guys. They want all the benefits (i.e., money) but don’t want to do the work required. They want someone else to tell them what to buy. Don’t be like them. Be like Livermore, Minervini, Kullamägi, and other great traders out there (even me). Do the work!

I think that loving to work long and hard is a skill that can be learned (not necessarily taught). If you want it bad enough, you will find a way. Start by reading about successful traders, studying charts, and learning to spot the high-probability setups. I know that you will be hooked because it is a very addictive game. Just like golf.

List of books that you should read

·        Reminiscences of a Stock Operator – Edwin Lefevre

o   Very entertaining about the trader “Larry Livingston” who is really Jesse Livermore, about his life and trades in the late 1800’s and early 1900’s.

·        How to Trade in Stocks – Jesse Livermore

o   Livermore’s own book contains everything you need to be a great trader. If you only read one trading book in your life this is the one.

·        Trading in the Zone – Mark Douglas

o   Great book about trading psychology and discipline. Want to know about those traits I mentioned in the beginning, then this is the book.

·        How I made 2m in the Stock Market – Nicolas Darvas

o   Just what it says on the label. Darvas explains how he learned to trade by trial and error, lots of errors, before finally becoming a successful (part time trader). Great motivation.

·        How to Make Money in Stocks – William O’Neil

o   About of the CANSLIM approach to trade combining fundamentals and technical analysis. If you don’t think patterns repeat in the market this book will change your mind.

·        Trade Like a Market Wizard – Mark Minervini

o   Lots of details of entries, exits and stops as well as a pattern recognition and money management.

·        Trade Your Way to Financial Freedom – Van K. Tharp

o   Book about the extremely important, but often neglected, subject of money management and positions sizing.

·        Secrets for Profiting in Bull and Bear Markets – Stan Weinstein

o   This is an all-encompassing book of who to trade. What to buy, when to buy, when to sell, where to place stops and more.

·        Market Wizards – Jack D. Schwager

o   There is a whole series of these book with interviews with great traders. Want to get into the head of the best traders the world have ever seen, then this book is for you.

Advice for the Newbie Trader: Cut out the Bullshit

The trading world is full of traps for the beginner trader. People are always trying to sell you something. It could be flashy programs with lots of colourful flashing lights and charts. It can be strategies with a 99% win rate, trading courses, trading seminars, and of course, indicators.

Sometimes when an indicator is described, it is described as a “lagging” indicator or a “backward looking” indicator, since it uses past data. I hear this from both finance influencers who only care about clicks and views and have no clue what they are talking about, but also from people who ought to know better. It suggests that there are indicators that are forward looking or “leading indicators”.

All indicators are lagging and backward looking. All indicators use past data in their calculations. Indicators are calculated using the price and sometimes volume. We do not have price and volume data from the future. Show me one indicator that is using data from the future! That would be some indicator!

In the case of the influencers, it’s a matter of not knowing any better and not caring. For those who should know better, I think it is a matter of not thinking things through. They are just using a standard expression and throwing it around. It has been used for so long that it is taken for granted and nobody actually realises what they are saying.

But there are brokerage firms out there who are also trying to sell the concept of leading indicators. Here is a quote from the website of one of them:

“Leading indicators predict the future price movement of currency pairs by using the current price data. It provides traders with ideal exit and entry price levels before a strong trend in the market begins.”

Here is another one from a well-known financial website (otherwise a very good one actually):

Is MACD a Leading Indicator or a Lagging Indicator?

MACD is a lagging indicator. After all, all the data used in MACD is based on the historical price action of the stock. Because it is based on historical data, it lags the price. However, some traders use MACD histograms to predict when a change in trend will occur. For these traders, this aspect of MACD might be viewed as a leading indicator of future trend changes.

They make it sound like they can predict the future. Please don’t fall for this. There are no “leading indicators”. They cannot predict the future; no one can! Also, if they had managed to create an indicator that could predict the future; do you think they would sell it? If I had found such an indicator, I would trade it and keep it a secret, not sell it to the people I compete with.

This illustrates that you should never, ever, take anything for granted. It doesn’t matter what the source is; always listen with a critical mind. The person may not deliberately try to deceive you, but they may not be right either, or what they say works for them, but that doesn’t mean it will necessarily work for you.

That includes me. I guarantee that I will not deliberately mislead you or tell you outright lies. However, I could make mistakes. I am dyslectic so things do not always come out “on paper” as they appear in my head. What I say may work fine for me but, perhaps not at all for you. I write my articles from my own point of view and my own experiences, and they are not the same as anybody else’s.

That is why I always try to include links in my articles on my blog and on Medium, so that the reader should go and get a “second opinion”. I say try to, because I cannot always find any other good sources that adds value to what I write. But that doesn't mean you shouldn’t look for yourself.

If you are interested in a subject that I write about then you should go out and read other sources. As many as you can. What you will find is that there are often opposite opinions out there. I am certain that you will find someone who has the exact opposite view than me. In the end it is up to you to decide what you think.

This is especially true in trading since it is your own hard earned money that is on the line. You are the one who is responsible for the result of your own trading. If you take a strategy from Mr Finance Guru Man on YouTube and apply it with your own money, then you are responsible for the outcome. Not Mr Finance Guru Man, no matter how bad the strategy was.

It is easy for a newbie to get sucked into the flashy, romantic stereotype of trading after having watched shows like Billions and movies like Wall Street. Great as they are, they have nothing to do with the reality of retail trader.

Learn to screen and block out all the BS out there. In the beginning it may not be obvious what is BS and what isn’t and that is perfectly natural. When you are new at something you don’t know these things, it is something you have to learn. As you progress, you will learn, and you will be able to separate the BS from the good stuff.

Just be very sceptical to things you read. Have an open mind without being naïve. Educate yourself with material from many different sources.

 

 

Trade Examples Using the RSI

In this post I thought I should talk a little bit about the Relative Strength Index (RSI). How it is used traditionally and how I use it. I think there are some misunderstandings of how it should be used today. The RSI can definitely be a powerful tool but it also gives many false signals so you better understand how and when to use it.

I have an article on Medium about the RSI which is more of an introduction to the indicator and how it is calculated. If you want to read that first, you can find it here. If not here is a very short summary of what the RSI is.

The RSI is a momentum oscillator that measures the speed and change of price. It was developed by J. Welles Wilder in 1978. It is mostly used to find overbought and oversold conditions, where values above 70 is traditionally considered to be overbought and values below 30 as oversold.

The formula for calculating the RSI is:

If you want an example of the calculation, I suggest you check out the article on Medium.

Let’s start off with some examples of the RSI. All the charts in this post are courtesy of Stockcharts.com.

In this Tesla chart we have three instances when the RSI falls below 30, indicating an oversold condition, and every time price changes direction a goes up. Important to note is that price does not always immediately reverse direction. In fact it is rare that it does.

Tesla

Tesla

In the first instance, RSI dips below 30 when price is around 210. The price then continues down to around 190 before finally changing direction. In the second, we see the same thing. RSI goes below 30 and price goes up a little only to fall to new lows again before finally starting a little up trend.

In the last case, price do reverse immediately and very strongly.

Starbucks

In Starbucks, we see RSI rising above 70 after the stock gaps up in early November. Again, it doesn't revers direction immediately, but continues to rise while the RSI stay above 70. Then it finally starts falling and the RSI also goes below 70.

Starbucks

Robinhood

Here is a good example of when the RSI isn’t working that well. In February 2024, Robinhood started a very strong uptrend and the RSI climbed above 70. But there was no reverse in price. Price just kept on going with a little correction before moving even higher.

Robinhood Markets

This was a strong trending market and in those conditions the RSI just doesn’t work. The best market for RSI is a sideways trading range.

Examples of Trades

I used to trade this way. I scanned the markets for RSI overbought and oversold conditions, although I used the values 20 and 80, to cut out most of the noise. The downside of this is that I also missed some signals, but there is always a downside to every upside.

I still look at these conditions and I actually traded Starbucks on the short side in the example above. But in my opinion, there are too many false signals with this method. Instead I started to look for divergencies between the RSI and the price. That means that they go in opposite directions and that could indicate that a change in trend is coming. Here is an example of a trade I took in Apple that turned out to be one really awesome trade.

Apple

Apple

In March and April, there was divergence in Apple. Price made new lows, but the RSI was rising. When price made new lows only to bonce up again, I entered the trade with a stop just under the low. It was a great entry, not because what later happened, but because the risk I took was low with a very short stop.

When price then made huge gap a few days later I added to my position and added again after it broke out of a consolidation of a few weeks. I finally closed the entire position when the stock had a larger sell off at high levels.

The RSI was at or above the 70 level for about two months, but the stock kept rising. I good reminder that an indicator is just that, an indicator. It only indicates what might happen. I never take action on any indicator, only on price.

Ebay

Here is an example of a trade on the short side that did not go so well. I noticed that the RSI was falling while price was trading sideways. When the price did drop I took a short position. The price reversed almost immediately and eventually I was stopped out with a loss.

Ebay

In hindsight, this was not a good entry because it wasn’t such a clear divergence. While RSI fell the price when sideways, if price had been rising it would have been a better case. But sometimes these smaller divergencies work out, as in this trade in General Motors.

General Motors

General Motors

I had been looking at GM for a long time and noticed that the RSI was flat while the price kept falling. Obviously, RSI cannot fall below zero, but it kept hovering around 30 when the stock broke the falling trendline, the RSI started to rise as well.

I entered on the break of the trendline, and I am still in this trade. I wish I would have had the courage to add to my position on the way up but unfortunately, I didn’t. The RSI have given several overbought signals but the stock has just kept on rising.

Final Thoughts

RSI is no magic formula for success, no indicator is. Some people swear by it while others hate it. I used less than before but I still look at from time to time. When it comes to divergencies, I much prefer the MACD indicator.

As with any trading tool, it is what you make of it. If you find an edge with the RSI then you should definitely use it. If you want to be a trader then understanding the most common indicators is part of the curriculum, and the RSI is one of the most common.

If you want to know more about the RSI I have put together a few links for you.

• RelativeStrength Index (RSI) Indicator Explained with Formula – Investopedia
• RelativeStrength Index – Wikipedia
• TheRelative Strength Index Revisited – Research Gate (if you really want to nerdin on RSI)

Video from Charles Schwab with an introduction to RSI

Video from SMB Capital of how it can be used in short term trading