When I am setting up a trade, I always use Elliott wave and RSI as a wave count confirmation tool.
In this post I will show you how the RSI can help you confirm the Elliott wave count, and then indicate possible entry points.
Also, how Elliott wave and RSI, can help you stay in the market and ride a trend move to its completion.
I am going to cover:
- RSI DEFINITION AND WHAT DOES IT MEAN FOR MY TRADING
- RSI IN TRENDING MARKETS.
- RSI SUPPORT AND RESISTANCE ZONES.
- RSI DIVERGENCE AT TOPS AND BOTTOMS.
RSI definition, what does it all mean for my trading?
The RSI indicator Has definitely got one up over its competing oscillator in the fact that it has fixed points extremes at 0 and 100.
Rather than the relative floating extremes of say the Momentum or Rate of change oscillators.
In that sense it does give the trader a base to work from in judging one period of market action to another.
The RSI indicator is also smoother than it’s big brothers, Because it uses the Exponential moving average, it tends to be less jumpy and more consistent.
In general the RSI is interpreted as follows;
If the indicator is below 30, then the price action is considered weak and possibly oversold.
If it is reading above 70, then the asset is after a strong uptrend and could be overbought.
Because the RSI is used as a tool to indicate extremes in price action, then the temptation is to use it to place contrarian trades,
Buying when the indicator crosses 30 to the upside means you are counting on the trend reversing and then profiting from it. The same is true for selling when the RSI crosses down below 70 and using this a sign that the market is reversing from a strong uptrend.
Life is never that simple though, and more often than not, you will find that the risk involved in this type of simplistic approach is ruinous to you account balance.
New traders tend to gravitate to the RSI when attempting to delve into analysis for the first time.
It is easy to approach and easy to understand, it has fixed overbought and oversold levels and it tends to be correct over longer periods,
ELLIOTT WAVE AND RSI IN TRENDING MARKETS:
The starting point for me is always the Elliott wave count. Before even thinking about entering a trend trade, I want to see a completed wave structure on the chart.
When the wave structure is complete which calls for a turn in the market, I then look at the RSI add weight to my wave count.
The RSI is a great tool to show a shift in momentum in a market.
The chart below shows the GOLD price off the lows of late 2015.
This low marked a turning point in the trend, and the decline into the 1045 low completed a wave structure off the all time high.
It was time to start looking for a turning point.
We look for an impulsive rally in 5 waves off the low followed by a three wave decline, the confirming price action forms a higher low and an inverse head and shoulders pattern, which sets the market up for a corrective rally.
At this point both Elliott wave and rsi are indicating that a turn is on the cards.
Lets look at the RSI in this time period:
I labelled the first rise off the low as wave ‘1’ in blue. Wave ‘2’ blue formed a higher low.
At this point the RSI had begun to rise in a bullish fashion to indicate the rally was getting underway.
A low risk trade would be to place a buy order at the wave ‘1’ high,
with the idea in mind that wave ‘3’ was about to start and carry the market to new highs.
By reading the RSI as a trend strength indicator, we could trade the rally all the way to the top.
In this case the RSI is a great tool to guide your trading stance.
ELLIOTT WAVE AND RSI SUPPORT AND RESISTANCE ZONES:
The short rule of thumb is this: the RSI forms resistance to the price rising between 50 and 60, and the RSI forms support between 40 and 50.
Lets see how that works out in trending markets.
RSI indicates resistance in a downtrend.
During the price decline off the all time high, In the GOLD market, the RSI never registered higher than 60.
This RSI resistance zone held for 9 months solid,
And the first time the RSI broke the 60 level was an indication that the trend had changed to the upside.
The RSI resistance zone acts as a signal that the trader can use to ride a trend trade to its completion, rather than closing a trade too early.
During a trend rally, the RSI acts as a support zone between 40 and 50.
In Dollar Swiss above the move off the low was supported by the RSI 40 level through the most powerful periods of the price rise.
ELLIOTT WAVE AND RSI DIVERGENCE AT TOPS AND BOTTOMS:
Again, back to the gold market.
You can see that the RSI had flat-lined even as the price kept falling into the low , this condition is known as ‘divergence’ and is a signal that the price will turn soon.
The first divergence was followed by the largest rally in the gold price in over 9 months.
As the rally matures the RSI starts to diverge from the price again. The RSI forms a lower high into the high at wave ‘a’ in green.
At this point the RSI is signalling that the rally is about to end and the trader should close out the position.