Stocks Technical Analysis Indicators Part 2

RSI (Continued)

Reference Level

The 30-70 fixed reference level used in the standard RSI is a disadvantage if you are using time periods other than the standard 14 bars.

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Figure 5.6: Using an RSI 30 bars average, 30 and 70 levels are not reached anymore.

If you used a 30-bar reference, as shown  in figure 5.6, you would notice that the 30-70 levels are not reached anymore.

We can solve this by using a variable reference level.

Figure 5.7: RSI with a standard deviation reference level.

In figure 5.7, you see a simple way of achieving this by using a standard-deviation value referenced to the RSI 50 level in a predefined look-back period.

 

We set the upper standard deviation to a value of 50 plus 1.5 times the standard deviation over a 100-day look-back period.

 

This is demonstrated in figure 5.8 with a 5-bar RSI.

 

For bigger RSI time periods, the reference level moves closer to the 50 level, whereas for smaller periods, like our 5-day RSI example, reference levels move farther away to the 20 and 80 levels.

 

 

 

Figure 5.8: Lower and upper reference set to 1.5 standard deviations for a 5 period RSI.

The RSI custom formula with the variable standard deviation lines is as follows:
{SVERSIStDev}
period:= Input("RSI period?",1,100,14);
afwh:= Input("Standard deviation high side",0.1,5,1.5);
afwl:= Input("Standard deviation Low side",0.1,5,1.5);
afwper:= Input("Standard deviation period ",1,200,100);
SVERSIStDev:=RSI(C,period);
50+afwh*Stdev(SVERSIStDev,afwper);
50-afwl*Stdev(SVERSIStDev,afwper);
SVERSIStDev

M- and W-shaped Patterns

M- and W-shaped patterns are short time patterns visible in the overbought or oversold areas of the RSI indicator. 

Figure 5.9: M-shaped top and W-shaped bottom patterns are short term reversal signals.

Figure 5.9 shows small M-shaped patterns at the top and small W-shaped patterns at the bottom that give reliable short-term price reversal signals. Preferably, they’ll incline in the direction of the reversal.

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The second leg of the M-shaped pattern does not move above the first leg. The second leg of the W-shaped pattern does not move below the first leg. M and W patterns are unrelated to convergences or divergences between the price and RSI indicator. They are more useful when there is convergence because they are, at that moment in time, the only visible indicators of, at least, a short-term reversal.

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