The ideal technical indicator, according to Andrew Cardwell, Jr., is one that offers capability to identify and monitor the current trend, highlight overbought and oversold extremes, and give early warnings of a trend change.
“The Relative Strength Index (RSI) is such an indicator, offering the best of all worlds,” said Cardwell, president of Cardwell Financial Group, Inc., based in Woodstock, Ga. The RSI “is the cornerstone of my trading model,” he said.
Cardwell is a featured speaker at this weekend’s 20th annual Telerate Seminars Technical Analysis Group (TAG 20) conference here.
“In the lectures and workshops I have given, I have shown how the RSI can be used as either a completely independent trading model or an addition to and enhancement of a trader’s current technical approach. I use it as a completely independent model to identify trend, support and resistance, overbought/oversold levels, divergence, trend change, reversal and price targeting.”
Cardwell said most traders who use the RSI focus their attention on trying to identify bullish and bearish divergences. He said basic price and momentum divergence can and does help to identify extreme overbought or oversold conditions in market momentum.
“However, most traders fall prey to the concept of divergence and see it as the end or reversal of the prevailing trend of the market. All would be right in the world if markets were to reverse from simple divergence. But there are times when sentiment and momentum are so strong that the market continues to make new highs (or lows), which will keep the RSI at overbought (or oversold) levels for extended periods of time.
“Momentum and price corrections, when they do materialize, are usually sharp and swift. After these brief respites the market is then ready to resume its normal upward (downward) trend. With each successive new high (low) and divergence formed, anxious traders are ready to call for a top (bottom) and reversal of trend. However, in strongly trending markets, multiple divergences can and do develop, which only lead to corrections of the overbought (oversold) condition of the market.
“If a trader attempted to take positions based solely on divergences, he or she would need deep pockets and eventually exhaust his or her trading capital,” said Cardwell.
While Cardwell takes note of divergence, he said that only shows the market is overextended and needs to correct the overbought or oversold condition. Even though the RSI is considered a momentum oscillator, he said it has more values as a trend-following indicator.
“One of the guidelines I have established for myself is to identify a range for uptrends as well as downtrends. As the market trends higher or lower I will adjust the normal range of RSI (70-30) to account for the shift in market momentum and bullish or bearish sentiment on the part of the traders. The fact that this adjustment needs to be made in the range of RSI is one of the first indications that the market is undergoing a trend change.”
The ability of a trader to recognize a trend change quickly, reverse a position and trade in the direction of that next trend is the skill that traders must develop to be successful, said Cardwell. “By having a position in tune with the trend, the trader will have the opportunity to participate in the bigger market moves, which generate larger profits.”
Cardwell has what he calls “Three Keys to Success: have a trading program, patience and discipline.”
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