Developed by J. Welles Wilder, Jr. in the 1970s, the Relative Strength Index (RSI) helps quantify price changes and their momentum. The Relative Strength Index, commonly known as RSI, is one of the most popular momentum oscillators used by technical traders worldwide.
Today, we'll discuss a special technique called the Failure Swing of RSI that Wilder noted in his research. He emphasized that a Failure Swing appearing above 70 or below 30 is a very strong sign of trend reversal.
1. Failure swing at the top:
A Failure swing at the top occurs when prices create a higher high, but RSI fails to make a higher high and falls below the nearest swing low (the failure point) of the indicator - it triggers a sell signal.
A stronger probability signal is when the first peak of the RSI indicator surpasses the 70 level while the second peak oscillates below 70.
2. Failure swing at the bottom:
A Failure swing at the bottom occurs when prices create a lower low, but RSI fails to make a lower low and rises above the nearest swing high (the failure point) of the indicator - it triggers a buy signal.
A stronger probability signal is when the first trough of the RSI indicator falls below the oversold 30 level while the second trough oscillates above 30.
3. How is Failure Swing used?
RSI Failure Swing is used to initiate buy/sell positions by predicting trend reversals. This means positions are opened in the current trend and the upcoming (just formed) trend.
When the indicator creates a lower peak, or failure in an uptrend, or a higher trough, or failure in a downtrend, entry points are signaled by this indicator.
In an uptrend, traders can enter a sell position, and in a downtrend, traders can enter a buy position.
This method can also be used as an exit position if you have bought into an uptrend or sold in a downtrend.
Let's look at an example to see it more clearly:
In the examples above, we can see the reversal forming immediately after the Failure Swings are formed (RSI breaking out of the nearest highs/lows).
It's also important to note that Failure swings differ from divergence signals, divergence signals have a larger breadth (time) whereas Failure Swings typically resemble small M or W shapes with peaks close to each other.
I hope after this article, you will have another way to trade with RSI. You can exploit it in any direction you desire, whether to enter trades or to take profit (predict reversals).