The Range Reversal RSI Technique
Using a New RSI Technique to Improve Trading Signals
RSI techniques are numerous and they improve the way we use it. This article discusses the range reversal technique, a new way of validating the RSI’s signals.
Quick Introduction to the RSI
The Relative Strength Index (RSI) is a widely used momentum oscillator that plays a pivotal role in technical analysis, helping traders and investors assess the strength and potential direction of price movements in financial markets. Developed by J. Welles Wilder Jr., the RSI has a rich history dating back to the late 1970s and has become a fundamental tool for market analysis.
The RSI was introduced by J. Welles Wilder Jr. in 1978 in his book “New Concepts in Technical Trading Systems.” Wilder was a mechanical engineer by training and a pioneer in the field of technical analysis. He devised the RSI as a means to quantify the relative strength of a financial instrument, aiming to provide traders with a more systematic approach to identifying overbought and oversold conditions.
The RSI is primarily calculated using two key components: the average gain and the average loss over a specified period. Wilder’s original formula for the RSI involved a 14-day lookback period. The formula is a complex one, but it essentially normalizes price movements to a scale of 0 to 100, with readings above 70 indicating overbought conditions and readings below 30 suggesting oversold conditions.
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Using the Range Reversal Technique on the RSI
The range reversal technique uses a combination of the conservative RSI technique and a filter that looks for a ping-pong state. But what are those two terms?
The conservative RSI technique signals a buy opportunity whenever the RSI shapes a value above the oversold level after having been below it for at least one period, and signals a short opportunity whenever the RSI shapes a value below the overbought level after having been above it for at least one period.
The ping-pong state is the stable and healthy state of an oscillator that goes from the lower values to the higher values in a regular way. This means that it does not spend too much time on either ends (a condition of a severely trending market).
Take a look at the following chart. This is the reverse of a ping-pong state, where the RSI is glued to the bottom values (below 50) for an extended period of time.
The range reversal RSI technique uses the signals of the conservative technique but takes into account the following conditions:
For a bullish signal to be valid, the value from 55 periods ago on the RSI must be above 50%
For a bearish signal to be valid, the value from 55 periods ago on the RSI must be below 50%.
A variation on the range reversal technique is that to consider any value within the 55 periods.
The above chart therefore shows only one bullish signal. If we took only the conservative RSI technique (without the addition of the ping-pong state condition), then we would have had multiple false signals.
The next chart shows how false signals have been avoided within the pink circle. A normal RSI technique would have fallen into this trap.
The following chart shows more signals generated from the range reversal technique:
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