Trading Stocks and Spotting Potential Trend Changes w/RSI | Technically Speaking: Advanced Charting
good afternoon and welcome everyone my name is cameron may filling in for pat malawi it is uh two o'clock eastern standard time on a friday afternoon and that means that it is time for the weekly series of discussions called technical analysis advanced charting techniques and i think i have a good one in store for us today if pat's going to give me an opening i'm going to take it today we're going to be talking about very commonly used but i think also potentially commonly misunderstood indicator it's known as a relative strength index and we're going to be taking a deep dive into this i'm going to go to pace and hopefully everybody can follow but i want to go in a little bit more granular detail with the usage of this indicator i have a story to explain just why i'll do other all of that in just a moment but before uh we can get to our precise agenda and dive into this discussion i want to say hello to everybody who's checking in from around the country i've already been chatting forth with back and forth with some of you hello there wayne at vj sandeep juanita eva michael sarah kj dylan kelly ganesh matt oda lawrence george texas brad fanima and on that list goes chris b greaser lamar joanna everybody thanks for joining these webcasts week after week i'm a bit of the interloper here but i still recognize the vast majority of those names if you're checking out one of these webcasts for the very first time though i want to welcome you as well if you'd like to chat and let me know that you're a first timer i always like to see who the do who the new people are and finally if you're watching on the youtube archive after the fact enjoy the presentation but be aware that you're invited to join pat live every friday two o'clock eastern standard time is when this discussion kicks off and you know i also need to point out that my very good friend mike fairborne is helping us out in the chats today he has been a good friend of mine and a co-worker for more than a decade yeah we've all been doing this for a long time most of our coaches have been doing it for 10 15 even 20 years you start talking about brent moore's that guy's been at it for even longer as a full-time investment educator so let's get right to it we're going to start things off as we always do we always have to provide some important information regarding risk now as we go to that remember if you're not following me on twitter please do at cma underscore tda i know a lot of you follow me you see that i post on there regularly there's a lot of back and forth discussion that's not always available in these group discussions uh formats but at cma underscore tda if you'd like to follow me on twitter all right so let's talk risk for just a moment this is important information content we're about to provide as intended for educational informational purposes only options are not not suitable for all investors there's a special risk inherent options trading may expose investors potentially rapid and substantial losses any uh any decision you make in your self-directed account is solely your responsibility having success with your paper money is not a guarantee you can have success with your real funds as market conditions do change and they can change rapidly while this webcast discusses technical analysis other approaches including fundamental analysis may assert very different views and finally all investing involves risks including the risk of loss all right so let's talk about what we're going to talk about now i mentioned i'm going to be be going a little bit deeper into what is probably a familiar indicator to a lot of you so do this for me as i set the stage here chat in and let me know are you familiar at least with the rsi the relative strength index very different from the relative strength indicator relative strength is one thing rsi is another thing we're talking about rsi go ahead and chat that in i'd also like to know if you're feeling brave could you actually describe the formula for the creation of the rsi because we're going to be getting into that today the reason i want to get into specifics because this is what i want to do i want to talk about how it's constructed how it might be used to generate or to plan a trade and how the rsi might also be used to potentially recognize new or emerging trends a change in trend direction and then finally we're going to look at a bunch of charts at least a couple to get some good repetition with this indicator okay i thought yeah i thought i would see a lot of yeses there's definitely some no's out there juanita you're not familiar with the difference between relative strength and rsi i'm not actually going to be spelling that out i just want to let everybody know that there's one indicator one indicator known as relative strength and there's another one that's known as relative strength index they are very different so rsi relative strength index is the one we're going to be discussing today okay so those are our three objectives formula first we've got to understand how it's built second is how it's used third is get some repetition but the reason i wanted to get it how it's built for some traders they really like to know they like to look under the hood of a technical indicator they want to know how it how it works the thing that brought this to mind to me was about an hour and a half ago my wife came in she was headed off to run some errands came back in the house and said cara is completely dead in the garage true story hour and a half ago and i said okay use the other car i'll take care of this one and i went out took about five minutes popped the hood because i feel pretty pretty competent looking under a hood when there's an issue and ran a series of tests quickly determined yep it is it's it's not a bad starter it's not a bad alternator it's a battery going bad so i can swap that out it'll take me you know 10 minutes after we wrap things up today but in any case yeah some people like to know what's going on under the hood others just want to know how to drive the thing right nothing wrong with that but we're going to go under the hood first so let's talk about this relative strength index the very first thing that i'm going to do is i'm going to apply that i'm going to apply the relative strength index the rsi to a chart of the s p 500 okay so let's switch up show you a chart of the s p 500 and um and let's get into it so we're going to pop up here this is just on paper money on thinkorswim and i'm going to go up here click on the little beaker icon or the flask icon i'm going to type in rsi and there it is rsi says plain old rsi it's not one of these other ones rsi we're going to add that to the chart and you'll note before we put it on there there are a few numbers that are going to be important and i'm going to explain each of these numbers 14 70 30 the fact that we're dealing with closes that just means this is generated using closing values okay rather than like intraday values wilder's is is giving credit to the to the creator of the indicator but i'm going to click apply and click ok and we're left with this oscillating black line and then these two purple horizontal lines now you'll notice that this oscillating black line if you squint when it goes above the upper purple line that changes color and when it goes below the lower purple line it changes color all right a final note about the construction of this indicator is it is range bound it goes from zero to a hundred it can never go below zero it can never go above 100 and we have this red part of me this purple line at 70 this one at 30. so let's talk about how this is constructed this whole indicator comes from one pretty basic equation so here's your rsi equation rsi is and i know this is bit of math my apologies the equation is 100 minus 100 divided by one plus we have to throw in some more parentheses here uh the average percent gain divided by the average percent loss looks like it's not quite fitting in on one line i want it to fit on one line so let's expand this out a little bit see if we can give it some more space there we go so there's our equation now before and let's throw in that final there we go just to make that a balanced mathematical equation what exactly is this attempting to explain to the investor or to the trader well this is taking a closer look at recent history so now the very first thing that i wanted to talk about was that number 14. if you remember when we were adding this down here we had these three numbers right here 14 70 and 30. so this
first 14 uh refers to the length of the amount of data that's being used to generate this indicator so if we're on a daily chart that's what we're using right now this indicator is looking over the last 14 days and really what it's attempting to confirm or to contradict is is strength in the markets or is strength in this chart actually reflected in the in the gains or losses on a day-to-day basis here's what i'm talking about let's suppose you look at it you look at a chart and over the last 14 it's last 14 days it's had i don't know nine up days and or let's say it's had nine down days and five up days what would you suppose is the sort of prevailing momentum of that chart just given that information nine down days of the last fourteen five up days down days clearly outnumbering the the up days and you might think oh okay well that's a bullish stock or index or whatever but upon closer examination let me add a little bit more data and let's say that on those five up days we averaged let's say a three percent gain and on the nine down days we averaged a one percent loss so yes the up days are coming a little fewer and further between but there seems to be more commitment in those it might not be otherwise obvious on the chart because the updates are getting swamped by the down days but it may be telling a very different story about the potential for momentum that is what this is doing the rsi is examining those last 14 days just looking to confirm is is uh is strength really there present when the buying is happening or is it when the selling is happening so let's let's spell this out with i'm gonna i'm gonna take that example that i just gave you the sort of hypothetical scenarios and plug them into this equation okay um and joanna says volume may play a role there's yup you're right joanna there's always something else that we could bring in to hopefully improve our analysis or expand our analysis right volume does not play a role in the in the in this particular indicator yep okay so um here's the here's the calculation we always start with 100 and we subtract this we take 100 divided divided by 1 plus our average percent gain over our specified period of time the default here is 14 days it can it can be customized if we wanted to but the default that the the indicator was constructed by its creator using a 14-day um period and that's typical it's it that would typically be used for something like a shorter term buy signal or a sell signal it can also have implications for intermediate or longer term trend changes we're going to talk about that but let's get our average percent gain and in our example let's say it was three percent right our average percent loss in our example that i just uh threw out there was one okay well this is starting to look a lot simpler right so let's let's just sort of play with this let's i'm going to leave this up here but i'm going to copy this and i'm going to paste it let's throw it just below and scroll up so that's not getting squeezed off the top all right well we know 3 divided by one what is that that's three okay so now moving a little bit further to the left one plus three is four and then 100 divided by 4 is 25 and that would ultimately generate for us an rsi value on our 0 to 100 scale over here of 75 in this uh in in this hypothetical example but that's pretty real that's pretty realistic that's real life there one thing that i want to point out yes wayne it should i was kind of hoping to slide that past shouldn't the plus right over here can this also be included or enclosed in parentheses yep my apologies i think everybody's following though good enough yeah all right i want to look at that somebody's asking about divergence is definitely on the schedule to be discussed today yes but right now we're still we still have our head firmly under the hood right i want to just talk about um how this how changes in these two variables are going to change this outcome generally speaking the stronger the average gain versus the average loss what that does is it gives us a larger denominator here and when we have a numerator that's divided by a larger and larger denominator we wind up with a smaller and smaller value and when we have that small value to be subtracted from 100 it gives us a higher net value i know yep you're gonna have to go back and think that one through and watch the archive if you want to this is just for those maybe the engineers or the tinkerers in the audience that the car mechanics that need to know how the engine works if we have a weaker and weaker average percent gain versus the average percent loss we're going to get we're going to get a smaller and smaller there's less there's a smaller number to be added to the one right and so that's going to have a smaller numerator 100 divided by a smaller number is going to give us a larger number here to be subtracted from 100 and that gives us a smaller number there so it really does reflect very nicely the the changing strength between average by average gainers and average losers and it gets reflected those differences get reflected from day to day as those things change it shows up as this oscillator which can never go below zero because we can this can never generate a number less than zero okay it can also never generate this equation this algorithm could never never generate a number greater than 100 so we get this fluctuation so what does this mean conceptually to the trader well if the equation is telling us that there that the average percent gainers have been so strong over the prescribed period of time relatively average losers it might be an indication that there's that the momentum that that uh that we might have been looking for maybe it was already there maybe it's already driven prices up to short-term peaks we're at exaggerated levels and we might classify that as what terminology do we use just generally speaking when we think the prices are too high in the short term or that they might be too high what do we call that you use this term using macd you use it using stochastic you can use it on cci you can use it on rsi it's sort of a general term overbought right yeah so when generally when a technician sees this indicator rise above this 70 level that might be an indication that our stock or our index is in overbought territory all right now to the opposite extent if we're generating very small numbers using this we might get down into oversold territory so if we were to let's let's see how we might generate that right so let's let's take a different approach let's copy this paste it down here and let's say instead of an average three percent gain we have an average one percent gain over the last 14 days and it's and then instead of an average one percent loss we have an average three percent loss okay let's take that and run that through right down here 1 divided by 3 is what 0.33 1 plus 1 plus 0.33 is 1.3 did i blow something here i don't think so just making sure i'm getting my math correct let's zoom in there one divided by 1.33 let's get our calculator for this one 100 divided by 1.33 is 75.
yup my math is correct there we go and then 100 minus 75 gives us what final value on our rsi that would be 25 so if we're seeing we're seeing quite a bit of selling versus buying confirmed by higher percentage losses than gains well that's gonna that's going to over time drop our indicator down into that oversold territory which is generally seen as being 30 and i'm going to throw out that word generally very tentatively because that i think can be stated um sort of in a textbook way however when we go to practice when we go to apply this in reality we might see a different very scenario a very different scenario okay that's it but are we feeling pretty comfortable with how this thing works is that a long enough look under the hood and we're starting to tie that to how to drive the vehicle right we look for these potentially overbought and oversold at least conceptually again this is not this is not me trying to convince anyone out there that this is the indicator for them but this is one of those that some traders will use maybe in combination with other elements of their technical analysis to plan a stock trade or even look for oh did we get a survey we did thank you vijay i just noticed that vj already did the survey we do have a link a survey link i'll come right back to that thought in just a moment but this is an indicator that some technic technical traders or chartists will use in combination with other indicates indicators or technical techniques to plan trades or maybe even spot trend changes there we go but to go to that survey link you'll notice i got a little bit excited because not all of my webcasts are surveyed so if you haven't ever filled out one of our surveys if you would do this for me as a favor click that link right now then fill the survey out after the webcast is over but it's a really quick simple survey three multiple choice questions unless they've changed anything in the very recent history and a comments box and all that data is compiled and it's presented right to me so that i can use that to improve or refine my webcast it's definitely helpful not a wasted effort always appreciate it okay all right so we're getting comfortable with it with this indicator we've just talked through the theory we're starting to understand how the ranges are established and where we might look for potential signals and so an spx someone who's been following the s p 500 they might see this selling off of the markets and think okay well this is good because we recently were in the oversold area that can make us feel a little bit better something i want to point out though about the overbought and oversold that can be easily overlooked and that is for some technicians when an index or in a stock is in an upward trend and i'd like to get everybody's input on this if you have any experience with rsi let me know if this is the way that you you view these charts yes or no but what some some technicians will do is they identify the trend first so here's our potential trend sort of as i see it recently you even saw me tweet about this i have a tweet out just today right and again this is just one technical view of things it's not a guarantee of performance in the future someone else might have a very different view of things but when we're in a nice upward trend on a stock or an index rather than looking for the rsi to dip all the way down below 30 to indicate that we're in an overbought zone in the short term some technicians actually actually look at the 50 level i'm going to draw in a line here right at 50 right there now as i do this this is where i want you to say for those of you who have used rsi to any real extent have you noticed the same thing a stock or an index is nicely trending up you'll very rarely or comparatively comparatively rarely actually get to the lower reversal zone or the oversold area or whatever you want to call it down here instead we might just be looking for a dip below 50. look what happens on this indicator in an upward trending market in this case upward trending index we dip below 50 that coincides pretty nicely with these lows there's a low there there's a slight dip below 50 i think we might have just gotten yeah just a shade we got to 49.3 right there we rally up we got down to a low here what was our low 41.12 got below 50 again below 50 again you can see how that's coinciding with some pretty nice lows and so if we're using that let's say an s p follower is using this to gauge all right so when when we dip below 50 that's maybe when i go look for some stocks or add to existing positions that seems to be a better indication in the near term than waiting for us to get all the way down below down below this 30 level now it's interesting once we slipped below 50 this is kind of like support and resistance right in this case the s p actually got significantly below 50 and then for a time that rsi 50 level was an indication that there's some weakness going on in this trend and you can see stocks struggling to get back up above in the same area struggling to get up back up above rsi finally we get back up above rsi again we even establish we get all the way up into the overbought range maybe confirming the strength of the current trend and in this case maybe those traders are saying to themselves all right pump the brakes i'm not adding to any new stocks right now we'll wait maybe see if we can get down back down below 50. there's another example
another example another example here so pretty interesting potential application through a different lens this is not one that you always see i've read quite a few books on this indicator quite a few little articles and things and it's sometimes they mention it i'll be fair more recently there seems to be more consistency in bringing up this tendency for the rsi uh frequently though there's no mention of this tenancy so in the take home message is the rsi in an upward trending stock that's been consistently upward trending or an index rather than looking for oversold at 30 we might be looking at oversold at 50. so if we take that if we take that logic and we apply it to a bearish trend what might that imply for overbought and oversold well the overbought level now becomes 50. which kind of changes the scenario recently right i mentioned that this might be used to plan stock trades might be and we'll we'll look at another stock just to get some repetition with this after we've talked through all of it but it also might signal trend reversals what do you think does it not seem like maybe there's some additional significance here if we haven't even been below 30 in over a year and then we finally get there that's something new that's different the interpretation by some technical investors is this might be an early sign of a trend reversal happening here yeah instead of this being an overbought hey let's get lots let's get heavily bullish it may be part pardon me oversold let me use the correct terminology there instead of this being an oversold condition and let's get maybe heavily bullish this might be a sign of caution if there's been a long stretch between lows below 30 it might be a signal that a trend is reversing particularly if we rally up to the 50 level and then find weakness again interesting could we pop back up above 50 could this drive up through this price resistance level it certainly could yup now vj you just that was perfectly placed i was actually starting to think how am i going to now how am i going to make the transition here well there's another way that this technical indicator might be interpreted and that's using something known as a divergence there was actually maybe even an earlier sign of a potential trend reversal here right bj let's do some very basic technical analysis right sometimes when we're talking advanced technical analysis we go back to basic principles right and in this case you'll notice s p if we're doing just some basic technical analysis we might look right here and say oh we're hitting new highs and compared to the high just before we're looking good right and then we hit new highs again right there okay so what we're getting here is higher highs on price but are those confirmed as we get into the internals as we look under the hood here were the highs established in this time frame on the rsi and then as we move forward to january highs that is a substantially lower high what that might mean is that even though there's a rally there might be less support for that rally and that might signal that there is a shift coming so a technical trader when they see this behavior on the rsi it may actually cause them to pump the brakes and say i'm not putting as much confidence in what i'm seeing on the price chart as maybe as i did back here there we go and and then we see what's happened since then so some potential uh some interesting potential applications none of these are guarantee of price performance right you'll notice we'll commonly um combine what we're seeing on rsi with what we're seeing on price for example the way we interpret the 50 level is influenced by what we see in the price trend right so let's see if we can go plan a trade let's see if we can take this new knowledge this new understanding of this engine that we're trying to make drive this vehicle for us and we're going to go to berkshire hathaway b shares okay this one i thought had a nice example i just want to go back through what we just learned let's look at this period from february leading into early june what is the trend there what is the trend are we not getting higher highs and higher lows on that price chart yeah the trend is up okay well what might that imply regarding our interpretation of the rsi where are the entry signals on rsi are they going to be down below 30 or are they going to be at 50. yeah they're going to be at 50. this is
interesting if i draw in that line at 50 let me get it as precisely as i can right about there's as close as i can get it let's carry it over here it was at 50 11. there we go look what we got right here we have upward sloping trend line there's a pull back maybe we suspected hey where it looks like we're getting close to our trend line again right and our rsi dips below 50. it's in that oversold in an upward trend territory if we're waiting for 30 we're not going to see anything like that all right so we just keep trailing higher once we get that entry signal you know maybe bouncing off this trend line that's our first indication maybe it's time to buy a confirmation might come from this rsi in the oversold popping back up slipping back up above the 50 that's a pretty common confirmation of that entry signal where do we get out well we could actually wait for the rsi to go back up to the oversold area and use that as a target in this case berkshire hathaway just happened to go through a really nice run up did we know that was coming probably not a technician might apply any number of other reasons for exiting a shorter term trade they might just be looking to get back up to this high that could have been a reason to get out right um maybe they used uh if there were some other obvious resistance level there you know we don't have enough information on this chart we might have to go back and look at historical charts go back further in history to see if we can find that but just be aware we're not obligated that just because we're buying because the rsi that it has to generate our sell signal we can combine that with other other reasons to get out of the trade okay now look what happens on our price chart we're going up nicely what's starting to happen with our rsi price chart in this case is actually leveling off but rsi is fading that might be a signaling a change in trend and as a matter of fact we did change trend after that so let me activate this drawing pull this out to the right and what's our trend our highs went sideways right and actually our lows went sideways from there so that divergence on the rsi might have been an early signal that that a trend change was underway and that might change our interpretation of our indicator all right now in this case what might be what what might we be looking for as a signal well we might be looking for rsi to get down below 30. in this case we
didn't get below 30 we had a few near misses though there's one there one there one there very interestingly could it have done much better at identifying potential lows here and here and there nope and if we're looking for getting low getting down 230 preferably or maybe just getting close and popping up above well then maybe we have a plan to get in and just out at the next resistance level there we go so i love that you're bringing in lots of other technical indicators some and maria's saying is there a triple top there like here henry one two three possibly possibly the trend was right to indicate we might have a triple top because trend was going up triple top is a reversal pattern so we hit one there's two there's three what disqualifies this as a triple top is that we never got below the lows the confirmation of a triple top is to break below support so this one just played out as a rectangle so when we're looking at triple p potential triple tops or potential triple bottoms we can't assign that label until we actually break out of the pattern until then all of those are just rectangles which are actually continuation patterns all right so there we are should we just look at what we're doing today okay what happens what happens here this is actually not a divergence but we did get pretty prominently higher lows on our rsi we got up to this overbought range which we hadn't seen in a long time and if we haven't seen something a long time it might signal that something new is underway right and in this case that was an early signal that trend was changing again so once again where might we be looking for the next entry signal from rsi are we going to be holding out for getting close to or below 30 nope we're looking at below 50 right there pretty good job of spotting that low right there so those are some examples in this case most of them worked out that was to teach a concept but is this a guarantee that you know we're going to see perfect signals every time nope we bring our other technical tools to the game and we and we try to make the best decisions that we can and we have plans for managing profits if they materialize or plans for managing losses also if they materialize if we get in because we see rsi signaling to get bullish and we think we're going up to a resistance but but instead we break support what might the trader do that pull the plug on the trade right there we go everybody i hope that you have enjoyed this discussion i think there's a lot of you out there do this for me i haven't i haven't asked this of anybody i want to ask those who already knew about rsi do you now know more about rsi than you did when we started that was what i wanted to do raise the game for those that were veterans with this already so i have that question for you say vet here yes i know more i want to know that or if no you already knew all this that's great too now for for uh for those who had never heard of the rsi do you feel pretty comfortable with the rsi because i want to go at a pace that's valuable to everybody yeah good all right then that means i can let you go and enjoy your weekend and i can feel good about things so let's wrap it up all right there we go so everybody when we set out i had three objectives i wanted to talk about how rsi was constructed really understand how that engine turns right then we wanted to talk about how it might be applied to identify not only the planning of a trade you know when it might give us entry signals but also how it might signal potential trend reversals and then finally we wanted to get some repetitions with some charts and we saw a bunch of examples on the s p 500 we saw a bunch of examples on berkshire hathaway b shares all of those were just for example purposes but that's check check check for all three of our objectives do me this final favor as i let you go just down here by my shoulder is a little blue button it's a subscribe button if you would subscribe to our channel our trader talks channel it makes your life a whole lot easier because there's a lot of noise out there on youtube you know it and i know it you see a bunch of people posing in front of fancy cars trying to give us the next next exciting thing right there's no fancy car behind me there's just a legitimate td ameritrade logo right yeah subscribe to the channel it cuts through all the noise and and it just makes it easier to follow your favorite instructors and your favorite uh webcast series all right everybody thanks for joining me today hey thanks michael for helping out in the chats here's your final opportunity now that survey has been posted in the chats if you could click that survey again once once ahead once again as a reminder it's a super quick survey and it goes right to where you would hope a survey would go to all right so um let me let you go everybody as we leave just remember that risks are real we did use real examples in this in this discussion it's not a recommendation or endorsement of those securities or those strategies and it's an educational experience for everybody i will see you next week monday through thursday i have new webcasts every day of the week pat will be back next week for this webcast but my next one would be getting started with technical analysis and i think even you veterans here could it could uh vouch for i try to add value for everybody of every experience level there so if you want to join me there it's 11 o'clock eastern standard time on mondays but everybody thanks for giving me your time today i will see you next week whether that's on monday tuesday wednesday thursday whenever that moment arrives i want to wish you the very best of luck and happy investing bye you
2022-02-06 07:24
