Good Trading requires the Best Charting Tool!- The True Strength Index (TSI) is a very popular and widely used momentum oscillator.
- It helps traders determine the trend and overbought/oversold market conditions.
True Strength Index (TSI) is a very popular and widely used momentum oscillator that helps to determine the trend and overbought/oversold market conditions. William Blau developed the TSI indicator and in 1991, presented it in the Technical Analysis of Stocks & Commodities magazine. The true strength index indicator consists of two lines, the index line and the signal line. The signal line is actually the exponential moving average of the TSI. Apart from the determination of trend and overbought/oversold market conditions, traders may use the TSI indicator to look for centerline crossovers, divergence, and signal line crossover.
Interpretation of the True Strength Index indicator
The true strength index indicator is a variation of another very popular indicator called the Relative Strength Indicator. TSI indicator shows very limited time lag as compared to moving averages. Therefore, it is one of the most efficient and effective tools to identify trends very early. However, it is imperative to know how to interpret the TSI indicator.
As we have already stated that the true strength index indicator consists of the index line and the signal line. The crossing of TSI above the signal line indicates an upcoming change in the trend. TSI indicator provides early buying or selling signals in this way and traders do not need to wait for TSI itself to move above or below the zero.
Traders can also look for divergence between the price movements and the indicator. Suppose that the price is making new lows but TSI isn’t equally responding, it indicates that the momentum is shifting gear and it may be a potential buying opportunity. Similarly, when the prices are making new highs but the TSI fails to reach new highs, it is an indication of weakening momentum and a potential shorting opportunity.
As far as overbought/oversold levels are concerned, every indicator has its very own and unique preferences. Typically, indicators use two values -25 and + 25 to determine overbought/oversold market conditions but -/+30 and -/+50 are also common values. TSI indicator indicates oversold market conditions when TSI crosses below the signal line combined with TSI below -25. Conversely, the TSI indicator shows overbought market conditions when TSI crosses above the signal line and TSI is above +25.
True Strength Index formula
True strength index calculations are not much complicated but do have a lengthy process. There are three stages of the TSI indicator’s calculations, double-smoothed price change, double-smoothed absolute price change, and the final TSI.
The double-smoothing method has the following steps:
- Calculation of change in prices from one period to another.
- Computation of the exponential moving average of 25 periods relative to the price change.
- Calculation of the exponential moving average of 13 periods based on the 25-period exponential moving average.
The true strength index’s double smoothing price change formula is:
- Price change = Current price level – previous price level
- First smoothing = 25 – period EMA relative to the price change
- Second smoothing = 13 – period EMA relative to the 25 – period EMA
While the true strength index formula is:
TSI = (Double-smoothed price change / Double-smoothed absolute price change) × 100
How to use the TSI indicator in trading?
The use of the true strength index indicator is very simple and it bases on simple indications. TSI indicator generates a signal whenever TSI crosses the signal. When the TSI crosses above zero, it is a signal to buy. When the TSI crosses below zero, it is a signal to sell.
The TSI indicator generates the second type of signals when the crossover between the signal line and the TSI line happens. When the TSI line crosses above the signal line, it is a buying signal. When the TSI line crosses below the signal line, it is a selling signal.
Another way to use the TSI indicator is to take advantage of overbought/oversold market conditions. TSI indicator indicates oversold market conditions when TSI crosses below the signal line combined with TSI below -25. Conversely, the TSI indicator shows overbought market conditions when TSI crosses above the signal line and TSI is above +25. When the TSI moves back above -25 after going below, it is a signal to buy. When the TSI moves back below +25 after going above, it is a signal to sell.
Technical analysts and experts always advise increasing the TSI settings to avoid whipsaws. Traders also get faster signals from the TSI indicator if they prefer to use shorter periods for the TSI but it increases the risks of whipsaws and unreliable signals. Traders may also use longer periods for the TSI to get fewer whipsaws and unreliable signals but at the expense of lags and lower risk/reward ratio.
True Strength Index indicator trading strategies
True strength index trading strategies are quite simple but traders must need to be fully attentive and vigilant. They must recognize signal line crossover and centerline crossover. When the signal line crosses the TSI line, it is a signal line crossover and its occurrence requires a long position. It is a selling or short-selling signal when the TSI line crosses below the signal line from above. When the TSI is above the signal line, it is a buying signal and when the TSI lies in the overbought zone, it is a selling signal.
Centerline crossovers are also equally important for trading signals. Traders decide on the basis of the indicator’s value being positive or negative. When the indicator is above zero, the price momentum will be positive, and below zero, it will be negative. When the price momentum is positive, traders prefer to enter a long position and they may prefer a short position when the price movement is negative.
TSI indicator also helps to identify areas of support and resistance and traders use those areas to identify breakouts and changes in price momentum. The selling usually continues when the TSI indicator breaks below a trendline. The TSI indicator also helps to spot divergence. When the TSI is dropping but the price of an asset is increasing, it is a bearish divergence and may lead to a falling price movement. A bullish divergence occurs when the TSI is moving higher but the price is falling. A bearish divergence signals upcoming upwards movement in prices. However, traders and technical analysts believe that divergence is a poor signal and traders should wait for the other TSI indicator’s signal or signals from any other technical trading tool.
Conclusion
The true strength index indicator is one of the most amazing technical analysis tools. It helps to identify trends, overbought/oversold market conditions, centerline crossovers, divergence, and signal line crossover. All of these trading signals are very crucial. The TSI indicator is an oscillator that works on the basis of positive and negative values. Positive TSI values indicate a bullish trend while the negative values indicate the bearish trend in the market. The TSI indicator has also certain limitations. For example, all the TSI indicator’s signals may not be true or it usually changes direction without the change in direction by the prices. Therefore, expert traders and technical analysts advise using the true strength index indicator in conjunction with technical analysis tools to avoid false trading signals.
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