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

Indicators – Great Tool or Totally Useless?

If you are new to trading, you have heard the term “indicator” and that they are vital tools for traders. Well, maybe. Sometimes. In my opinion, there is a lot of misunderstandings about indicators and far too much confidence in them.

That is way I am now starting a little series of articles on indicators, both here on the blog and on Medium. On Medium, I will do more of an introduction or overview of them and here on the blog, I will go into more detail of how they can be used and how I use them.

What is important to know is that all indicators are derived from price data. Some indicators allow use volume. But the thing is that you already have the price data on the chart, all indicators do is to recalculate that data and present it in another form.

Years ago, I was told by a seasoned trader who didn’t use indicators at all, that you could always look at price and estimate the indicator but not the other way around. That is very true, you can. And with that argument, you would think that indicators are useless. Well they can be, but they can also not be. Confused yet?

What I mean is that price is what matters. Add volume to that and you have all you need to trade. But indicators can be very useful to identify trends and potential turns in price. Although you can use price data for this, indicators usually make it much easier to see these things. They can make it easier to identify trends by cutting out the “noise”.

This post is just a teaser of the article series. Right now I am working on the first, which will be about the Relative Strength Indicator (RSI). It is one of the most commonly used and also one of the most misused indicators.

One thing I would like to emphasize is that indicators just “indicate”. They should not be used as buy and sell signal. I use them to scan for interesting stock and setups. Buy and sell decisions are based on price and volume. Only and always!

Setting Strategy Goals

”Sound strategy starts with having the right goal.”

-Michel Porter

We need to set goals for our trading. We need them so that we can evaluate our trading and become better traders. But what is a good goal and how do we evaluate and measure them?

Bad Strategy Goals

It is easy to set a monetary goal for a trading strategy. Perhaps making $10 per day or $1,000 per month. It makes sense at first. If you have expenses of $1,000 per month why not have a goal of making at least that amount?

I did this in the beginning of my trading career. I used to sit and think that if I made 1% per day with a starting capital of £1,000, how much would I have at the end of they year. Then I would do the calculation in Excel and come up with a nice little sum of £12,032 or 1,103% (assuming 250 trading days).*

Wow, what if I could make 1.2% per day? Then I would have £19,730 or 1,873%. All very impressive numbers but not realistic. Trading just doesn’t work like that; it isn’t that consistent. There will be losing days, losing weeks and losing months. Any losing streak will kill a strategy based on short term returns.

There is nothing wrong with having a monetary target as an overall goal. A million in five years or ten million before I am 50 are great motivators to get you out of bed in the morning, but for strategy goals they are useless.

Good Strategy Goals

What is a good strategy goal then? Most traders think in terms of performance instead of result. I know what you are thinking, but no, they are not the same. Results are monetary goals while performance goals are more of the type: risk vs reward, minimising drawdown or volatility of the P/L (profit/loss).

Another type of goal could be to simply improve over time. Am I better now than I were one year ago? If not, then why? If yes, then also why? That is one of my goals. I want to see that I am improving as a trader over time. These days it is more or less my only goal. If I am constantly improving, then I know I will increase my profits.

Another good goal could be to stick to the trading plan. Sounds simple but it really isn’t, especially in the beginning. I used to do deviate from my plan a lot as a newbie. Then when I looked at my trades, I could see that my worst trades were those where I had abandoned my plan just because I thought I saw something good in the charts.

If you have a plan that says that you should take trades when two moving average cross with increasing volume, then those are the trades you should take, not the ones where someone said something on Twitter.

Trading Goal for Newbies

Here are a few specific goals you can try out. You can have more than one goal as long as they are not conflicting with each other (I don’t any of these conflict).  Pick a few of them and stick to them. If you find that you are not able to, then ask yourself why. Was it because the goal was too hard or because I just deviated from my plan? Perhaps the goal just wasn’t a good goal for me to have right now.

• Follow the trading plan to the letter. DO NOT TAKE TRADE THAT ISN’T IN THE PLAYBOOK!
• Have a risk to reward ratio of a minim of x to 1. It could 2 to 1, 3 to 1 or whatever, but if you see a trade with a 2 to 1 ratio and your minimum is 5 to 1, then don’t take the trade.
• To have a win rate of x% over a longer period. This depends heavily on your type of trading and you need many trades to evaluate since trading is a streaky business.
• Limit losses by setting stops and sticking to them.
• Improve over time. Make sure that your win rate, draw downs, P/L volatility and result improve over time and or number of trades. The goal is to become a better trader; to become a great trader.

There is the old “SMART” acronym, Specific, Measurable, Attainable, Relevant and Time. Sure, I agree with that, but not all goal can be. The goal “to become a better trader” isn’t very specific, but very important in my book. It may or may not be measurable (results are just one aspect of improvement).

Updating Goals

After you have traded a while and you have a number of trades (at least 200 in my opinion), then you can analyse that data and come up with new goals. If you see that you make 5% per trade on average, on certain type of trade, then your goal should be to take more of those trades.

If you see that your drawdown was too big then your goal should be to limit drawdowns from here on.

You and your trading evolve over time and so should your goals. The goals that you had as a beginner might not be as relevant after a few years of experience (but they could still be of course).

But don’t spend hours on goal setting. Just pick one or two and then focus on working out a trading plan, study the markets, study the charts and trade. The best way to improve is to just do it. Trade – evaluate – repeat. That’s the magic sauce!

 

My First Article on Medium

 Just published my first article on Medium. All part of my endevour to battle my dyslexia. 

I could just post everything I write here but this is a brand new blog and has very few visitors (actually it doesn't have any yet). Also, but publishing my work on other plattforms I force myself to really edit my text and work on my writing, just to meet their criteria and guidlines.

The article is titled; Four Trading Insights for Beginner Traders. I write about three "issues" that I think a beginner trader should talk about before he or she start to trade.

First, that it is importarnt to have an income on the side. This to not having to take out money of the trading account. You want to make your trading account grow, not shrink.

Second, that you should be prepared to work very hard if you want to make it as a trader. Lazy people don't make good traders.

Third, is that you must understand that you will lose money in the beginning and that is totally normal. I beliver many trader quit after a few losses because you cannot take losing money. But you have to be able to take it, it is part of the game.

And lastly that you shoul never be satisfied with where you are to day. Always strive to become better and never stop learning new things. 

That was a very brief summary. If you want to read the whole article you can so here.

Four Trading Insights for Beginner Traders

The url actually says "three" instead of four insights. That's dyslexia for you :)