The Relative Strength Index or popularly called the RSI is one of the most popular momentum oscillators used by technical traders worldwide. Developed by J. Welles Wilder, Jr. during the 1970s, the indicator helps to quantify the changes in price and its momentum.
The very fact, that the indicator is still in use and is a part of almost all the charting software packages out there speaks volumes about itself and brings us to the conclusion that solid logic never goes out of style!
There are various ways of using the indicator. Here we will discuss a special technique called the failure swing that Wilder noted in his seminal work, New Concepts in Technical Trading Systems . He further added that “failure swings above 70 or below 30 are very strong indications of a market reversal.”
What is an RSI Failure Swing?
An Relative Strength Index failure swing is an advanced technique of trading RSI divergences.
In case of an RSI divergence, both price and the indicator diverge from one another indicating loss of momentum in the trend.
In case of an RSI failure swing, the same phenomenon takes place with a confirmation of trend change on a break of the fail point on the indicator.
One can wait for a failure swing to emerge on the charts to take more confirmed trades.
Failure swings are of two types, namely Failure Swing Top and Failure Swing Bottom. A discussion on both the formations is as follows:
Failure Swing Top: A failure swing top takes place when price makes a higher high but RSI fails to make a higher high and falls below the recent swing low (fail point) of the indicator triggering a sell signal.
More importantly, during the first high RSI goes above the 70 overbought level while during the second high, the indicator makes a swing high below the 70 overbought level.
Let’s take a look at an example. On the following hourly chart of State Bank of India we can clearly see that the impending sell off was foretold by the indicator.
Failure Swing Bottom: A failure swing bottom takes place when price makes a lower low but RSI fails to make a lower low and rises above the recent swing high (fail point) of the indicator triggering a buy signal.
More importantly, during the first low RSI goes below the 30 oversold level while during the second low, the indicator makes a swing low above the 30 oversold level.
In the daily chart of Asian Paints, we can clearly see how the stock picked up steam after the failure swing bottom was formed on the RSI indicator
To conclude, we can say that trading RSI failure swings could be a great way to trade off the charts that can have a positive impact on your portfolio.
You can also learn the technical analysis of stocks on Elearnmarkets.