21 August 2010

RSI in Forex

This follows on from my comments about RSI. If RSI smoothing and re-scaling works against the nature of the forex market as a computational system, where is it helpful ? Well, in extremes, because it finds accuracy now matter what smoothing may have been done to its data.

But let's look at RSI on USD/JPY 1 min, the most recent data up till market close on Friday. Now everyone who has looked at RSI thinks omg, all I need to do it trade on those spikes up (i.e. put an order counter to the trend).

It is true that RSI spikes tend seem to be more accurate than Stochastic spikes, which tend to move horizontally in the extremes. The problem is RSI is much less accurate, thus a move down from a spike can easily be a continuation of the trend.

So what else can you get from it. Well let's say spikes = direction, well where the RSI is in relation to 50 = momentum. So basically RSI is compressing information for you, about direction and momentum. That is what it means for me. It becomes part of that heuristic trading I talked about. It is like a news flash.

Let's look at what happened at 14:20pm on Friday USD/JPY 1 min. Spike, yet you really would not have wanted to go short on that. Moves into extremes are used by the computers, so whenever that happens, program sell or buy orders are being triggered. But these take time to clear. It is like hitting barrier options when a currency first goes to a major price level (e.g. EUR/USD 1.5). That is what is at the heart of the momentum.

The other thing to note about that is 'look to the left', it is clear of structure, it can keep on going. But there is structure at exactly where there is another spike and where you should have gone short. The RSI cleared opposing orders, in the move to that peak, and this shows as it went down slightly as prices continued up. A bearish divergence between prices and RSI ensued. But look at the cause, the price reference to the left, and the clearing of orders.

The MACD histogram was misleading as well, it showed a peak. But for me, as I said crosses are paramount in MACD, and there was a bullish cross above the zero line referencing what was happening here. That said to me, there is action still to come, but be careful.

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