The first example of
using technical indicators in combination with other chart signals
(in order to improve our probabilities of success) can be seen with
the Relative Strength Index (RSI). Put
simply, the RSI is
technical chart indicator which shows the momentum levels in price
activity. These momentum levels compare the significance of recent
gains in relation to losses have have been seen recently as a means
for determining when prices have become overbought or oversold for a
given period of time. These values in the RSI range from 0 to 100.
Assets are considered to
be overbought when RSI rises above the 70 level. This essentially
means that the asset has seen too much buying activity relative to
historical values and is now, in essence,
overvalued. When an asset
is overvalued, the market is more likely to begin selling that asset
in order to bring down its price. At the same time, when the RSI
falls below the 30 level, the indicator is sending a signal showing
that the asset is oversold and have become undervalued. In these
cases, it is more likely that the price of the asset will gain as
investors look to buy it at cheaper prices.
As always, an increase in
demand will mean higher market values in the future. When traders use
RSI, it should be remembered that large surges or declines in price
can have a distorting effect on the RSI but in most cases prices
proceed in ways that are comparable to historical trends. Now that we
understand how the RSI works, we will now look for situations where
it is able to really work its magic. Specifically, this means that
there will be other chart indicators which can help to verify
the readings on the RSI
indicator.
Below is a chart showing
our first example. Here, we can see that prices in the S&P 500
have reached a critical peak and have started to trend lower. But how
could we have forecast this later
decline?
Fortunately, a quick look at the
behavior of the RSI would have given us some critical clues which
might have given us a jump on the rest of the market and showed us
that prices were topping out and ready for a major decline. See the
chart example below:
Based on this information in the chart,
what trade should we have placed in the S&P 500? Well looking at
the RSI reading (which has crossed above the 70 level, suggesting
overbought conditions) the right trade would have been to enter into
daily sell order in the S&P
500. Additional reasons for placing a
Sell order in the index come from the fact that prices are showing a
clear downtrend (lower highs and lower lows) an we also have
resistance levels overhead which will likely keep prices from moving
higher. When considering all of these factors in combination with
each other, it becomes clear than a bearish scenario is in place and
there is
a much greater likelihood that prices
will fall in the future. Now, it must be understood that this is not
a guarantee that prices will fall in the future. There are no
guaranteed trades in the binary options market. If trading was that
simple, everyone would be doing it. But instead, these conditions
show a greater probability of a bearish out come (with prices falling
in the future). Because of these factors, Sell order have a greater
probability of success, and these are the trades that should be
placed.
Bullish Trading Example
Below is a chart showing our second
example, which should be a clear indication of an alternative bullish
example. Here, we can see that prices in the NASDAQ have reached a
critical trough and have started to trend higher. How could we have
forecast this later decline?
Again, a quick look at the behavior of
the RSI would have given us some critical clues which might have
given us a jump on the rest of the market. These clues would have
showed us that prices were
bottoming out and ready for a major
rally. This can be seen in the chart example below:
Based on this information in the chart,
what trade should we have placed in the NASDAQ? Looking at the RSI
reading (which has crossed below the 30 level, suggesting oversold
conditions) the right
trade would have been to enter into
daily Buy order in the NASDAQ. Additional reasons for placing a Buy
order in the index come
from the fact that prices are showing a
clear uptrend (higher highs and higher lows) an we also have support
levels just below which will likely keep prices from moving lower.
When considering all of these factors
in combination with each other, it becomes clear than a bullish
scenario is in place and there is a much greater likelihood that
prices will rise in the future. Now, it must be understood that this
is not a guarantee that prices will fall in the future. These
conditions show a greater probability of a bullish outcome (with
prices rising in the future).
Because of these factors, Buy order
have a greater probability of success, and these are the trades that
should be placed. Here we can see how prices actually developed,with
a strong rally in
prices coming next.
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