Overview of The True Strength Index

by The TSI Trader

The True Strength Index (TSI) is an extremely responsive momentum indicator with very little lag time in its representation of price movement momentum. The indicator is designed so that when it is rising above zero, price is also rising. Also, when the indicator is falling below zero, price is also falling.

Perhaps this sounds too good to be true, but it is true!

The challenge with using the TSI indicator is not with the conditions described above, but with the conditions not described above. For example, what is happening to price when the indicator is above zero and not rising? Or, what is happening to price when the indicator is rising but below zero? And so on.

Darn, just when we thought we found the Holy Grail to robbing the stock market for riches. There is always a catch, isnt there?

Fortunately, there is a fairly decent workaround to answer the questions I raise. And that is the use of adding a moving average to the TSI indicator. One can use a crossover of the indicator with respect to the added moving average in cases where price direction is not a certainty.

So, for example, if the indicator is reading below zero, the only certainty is that price will go south if the indicator continues to fall. But if the indicator is rising below zero and has crossed up through its accompanying moving average that can be taken as a buy signal.

This chart will demonstrate what I have discussed. This is a daily chart of GDX. The TSI indicator is displayed in the panel below price and its color is purple. The blue line is the moving average of the TSI indicator. Here I have the TSI indicator set to 13,13. The moving average of the TSI indicator is set to 3.

I have drawn vertical white lines where the indicator begins to cross up through its moving average line and white lines where the indicator fails to rise further above the ZERO LINE. This chart is 6 weeks of daily price movement and you can see that the indicator accurately gave us 3 nice buy and sell signals.

Here is another look using the same TSI and moving average settings. This time the chart is of GLD in a 60 minute view, rather than a daily chart.

And we see that in the past 6 or 7 daily trading sessions the TSI gave us a couple of nice buy and sell signals (vertical white lines). These trades were kinda no-brainers because the rising TSI indicator was above ZERO the entire time therefore we KNEW that price would be rising with it.

Also I will call to your attention the possible trade given us by our understanding of the Bollinger Bands. Buying on the break of the lower band (circled) and selling on a break of the upper band (also circled) would have worked out nicely. The timing of this trade would have been a tad different than the first TSI trade, but very similar.

By now the wheels in your brain should be spinning. What if a guy combined an understanding of the Bollinger Bands together with the True Strength Index? Like, use the two indicators together. One to confirm the other. Hummm..

Now I will show you a second trading strategy using the True Strength Index. This strategy uses the concept of divergences. Normally, when price is rising, the TSI is also rising. And as the price goes higher, the TSI goes higher with it. But sometimes what happens is that as price makes a higher high, the TSI does not confirm the rally by make its own higher high. When this happens it raises a bright yellow flag for caution and inevitably a sell signal.

Here is an example of a divergence where price continued higher, but the TSI indicator did not follow higher. Instead, it forewarned of decreasing momentum that would not be able to continue sustaining higher and higher prices. This a daily chart of the S&P500. Notice how the TSI was screaming SELL for days before the May 2010 mini-crash occurred, by diverging from the climbing S&P500 price.

We have also learned the technique of using a moving average on the TSI to generate buy and sell signals. Notice how the purple TSI indicator crossed below the blue moving average (and stayed there) for almost 2 full weeks before the crash!

Now lets look at another example of the True Strength Index where it gives us a SELL signal while price continues higher in divergence to the indicator.

This example is of daily SLV (silver). What is really interesting is that the TSI gave not one but two sell signals in the course of just a week or so. I have placed a white circle around price when it made a higher high while we see that TSI has made a lower high. Both these situations represented screaming SELL signals. Take a look. Notice how sharply SLV tries to correct the divergence.

But what about BUY signals? Well, the divergence concept works well for that, too. What follows is an hourly chart of Hecla Mining (HL). Notice how price is trading flat for literally 4 days. But the TSI is does not believe things should be flat! Instead, with stealth, it is rising and rising, closer and closer to the ZERO cross over. When it does crossover price explodes to the upside. Remember, when the TSI is rising above ZERO, it is a mathematical certainty that price is also rising.

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6 Buy/Sell Techniques using the TSI Indicator

see pictures in http://thetsitrader.blogspot.com/p/6-buysell-techniques-using-true.html

I have identified no fewer than 6 techniques for using the True Strength Index (TSI) indicator for the accurate generation of Buy/Sell trading decisions.

I will present these 6 techniques accompanied by charts and demonstrate their interpretation.

The 6 techniques are:

1. ZERO Crossover

Let's first begin with the ZERO Crossover, as it demonstrates the wonderfully characteristic 'truth' of the True Strength Index indicator:

a.) when the indicator is rising above the ZERO level, price is always also rising.

b.) when the indicator is falling below the ZERO level, price is always also falling.

This daily chart of the SPY ETF demonstrates the concept that when the TSI indicator is rising above the ZERO level, price is always rising.

This daily chart of the SDS ETF demonstrates the concept that when the TSI indicator is falling below the ZERO level, price is always falling.

2. Trend Line Break

The 2nd technique is called the Trend Line Break. A Buy signal is generated when a series of descending peaks are connected and the resulting trend line finally runs into an indicator reading that begins to exceed the downward trajectory of the line. This 4 hour chart of the DZZ ETN yields a couple of Buy signal examples using the Trend Line Break technique.

The Trend Line Break technique issues a Sell signal when a series of ascending troughs are finally met by an indicator reading that begins to fall below the resulting trend line. This 4 hour chart of the GLD ETF yields a couple of Sell signal examples using the Trend Line Break technique.

3. Positive/Negative Divergence

In the case of a positive divergence, price either holds sideways or makes a lower low, while the True Strength Index indicator simultaneously makes a higher low. What is going on here is that momentum (TSI) is improving while price seems to be going nowhere. This disagreement or divergence in direction is positive for the ongoing direction of price. This 60 minute chart uses the GLD ETF to demonstrate a rising TSI that is diverging in a favorable or positive manner from price.

A negative divergence Sell signal occurs when price trades sideways or even makes a slightly higher high, while momentum (TSI) concurrently makes a lower high. In this case, price appears to be either stable or improving, while the TSI, making a lower high, tells us that momentum is becoming exhausted. The difference in direction, the divergence, therefore portends a negative outcome for price. This 60 minute chart of the SLV ETF shows us how price usually resolves after a negative divergence setup.

4. Support/Resistance Line Break

The 4th technique for generating Buy/Sell signals using the True Strength Index (TSI) indicator involves the careful observation of the indicator's horizontal lines of support and resistance.

This daily chart of the GLD ETF illustrates the Sell signal generated when the horizontal support of the TSI is broken to the downside.

This daily chart of the SPY ETF gives us 4 Buy signs when the resistance level of previous high readings of the indicator are surpassed.

5. Nosebleed/Opposite

The 5th technique is what I call 'Nose Bleed' and 'its opposite'. There are times when the TSI screams higher to reach a level comparatively out of context with the recent past. Also, it happens in the 'opposite' manner where the TSI reaches low levels that are, contrasted with recent behavior, simply off the standard deviation chart. These situations, where the TSI movement exceeds the 'norm' themselves generate Buy and Sell signals.

This daily chart of the SPY ETF yields an example of the nosebleed Sell signal and 'its opposite' - the excessively low reading that generates a Buy signal.

6. Moving Average Crossover

Finally, the 6th technique involves the use of a moving average on the TSI indicator. The crossovers of the indicator with the moving average create the Buy and Sell signals.

This 4 hour chart of the UUP ETF arbitrarily uses a 9 period moving average to generate the Buy and Sell signals identified.

While I have identified no fewer than 6 separate techniques for using the True Strength Index (TSI) indicator, I find that the the trades with the highest probability for success will combine two, three and sometimes even 4 techniques. An example of this would include a Buy signal occurring just above the ZERO crossover as a result of a trend line break with a positive divergence in the previous bars.

Probabilities for a successful trade are also raised when additional indicators are combined with the TSI to provide confirmation of likely change in price direction. The indicators I often combine with the True Strength Index for this purpose include the Money Flow Index, Demand Index, and the Volume Flow Indicator. My idea here is to use other indicators that measure something a bit different from momentum, such as those that calculate volume, volatility or some metric other than momentum.

The True Strength Index (TSI) indicator is freely available via the Internet based charting software at FreeStockCharts.

I am open to answering questions and providing assistance to anyone interested in becoming more proficient at using the True Strength Index (TSI) indicator. Just write me an email with your questions, OK?

John

tsiTrader@gmail.com