Using RSI to Find Great Trades

12/06/2012 1:00 pm EST

Focus: TRADING

Andrew Cardwell

President, Cardwell RSI Edge

Andrew Cardwell is a pure technical trader who uses RSI almost exclusively to find good opportunities in the markets. In this interview, we talk with Andrew about his special twist to standard RSI settings and the one simple thing he uses in conjunction with RSI to make it even more accurate.

Andrew will be presenting a workshop at The Traders Expo New York in February 2013. Sign up now and be sure to attend his session.

 
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Tim Bourquin: Hello, everybody, and thanks for joining me for another interview today. My guest today is Andrew Cardwell. He's an expert in RSI, and we're going to talk to him today about how he uses it to find good opportunities in the market. So first of all, Andrew, thanks for joining me on Skype this morning.

Andrew Cardwell: Tim, it's great to be with you. I'm glad we had the time.

Tim Bourquin: All right. So your Web site is all about RSI. Why RSI? What is it about RSI that attracted you initially?

Andrew Cardwell: Well, I started as a broker way back in the dinosaur age, in the late '70s, and I was basically just a salesman for the firm. We were raising capital for the fund manager that traded through us who had an excellent track record. While I was making sales calls and he's discussing his performance I just got interested in technical work. I was an economics major in school so I was used to looking at charts and a student—not a student—another client at the office of my boss was using the RSI he had found in the Stocks and Commodities magazine back in '78. He shared it with me, and I started calculating values every afternoon and plotting them on graph paper. In fact, the first ten years I was in the business I didn’t even have a computer. I calculated the RSI values on a spreadsheet for about 15 markets and plotted them.

Tim Bourquin: Now, is it one of those indicators that you have various settings for or is there one setting?

Andrew Cardwell: Well, it's the standard Welles Wilder RSI that Welles developed in the mid-'70s. Most people look at it as an overbought/oversold tool. It has a range of 0 and 100 with an oscillator that swings up and down and supposedly identifies overbought and oversold. It's a very widely followed, but very less understood, indicator because most people are looking just for 70 and 30 and that's what Welles had talked about—overbought levels, oversold levels.

But it will show divergence when price goes to a new high and the oscillator fails to achieve a new high or the inverse. When price goes to a new low, the RSI makes a higher low, basic divergences. But divergence is not a reversal signal. It's not the end of a trend. I found working with it that it would blow right through that divergence and go to a new high and a new momentum high. So it's not an overbought/oversold as much as it shows that the market is overextended one way or the other.

Tim Bourquin: Okay, so I might use this then to not say it's oversold or overbought, I need to get in or get out. It is this one is reaching an area where it may reverse sometime in the near future?

Andrew Cardwell: It's just showing that it's overextended and due to make a correction or a pullback from overbought or a rally from oversold. Where Welles had talked about 70 and 30 by plotting something everyday especially back then it was 15 different markets, I was looking at the grains, the livestock, the cotton, the sugar, and I started following gold and silver, then the currencies and the interest rates and then after we started following the S&P futures.

But I found that people are by nature bullish. So what I did, Tim, was I adjusted the range and when the markets appear to be in an uptrend I would look for 80 and 40 as that 40-point range. When it went into a downtrend I found the RSI tended to top out just below the 60 level. So I started using 60 and 20, and this is where I defined what I called my range rules. I have students and clients who use it in mutual funds, stocks, futures, currencies, all types of markets.

So the RSI to me is an ideal indicator because it's incorporating not only price and momentum but it can also be used as a sentiment tool to see when most people are bullish, they get excited, it's going to go through the 70 level. When it corrects, it's not going to correct all the way down to 30. It will come near 40 and those who missed the train first out of the station are more apt to jump on it because by then you've established enough of a trend.

NEXT PAGE: What RSI is used for

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Tim Bourquin: So it's not particularly an entry or exit tool and it doesn’t really give you a particular level at which point you say it's ready to reverse and it's time to get in?

Andrew Cardwell: Oh, the way I use it and the way I've taught my students and my clients to use it, it's for trend analysis, identifying trend change and setting price objectives in the future in a new trend because if it gets overextended, you're going to have correction. Well, when the market corrects and the RSI sells off and goes to a lower level than it did previously but the price is higher, that's what I call one of my positive reversals. I'm then able to take the difference and add it to the last high and suggest new targets in the future in the new uptrend and say it's still going in that direction.

Tim Bourquin: Okay. Do you use this, say, for instance, if you've got an RSI that has a number on the S&P 500 and then you've got a stock within the S&P 500 that maybe is normally in line with that but is diverged, is that an opportunity as well maybe to see that something will change with an underlying stock?

Andrew Cardwell: You know yourself that not all stocks follow the trend of the market. I mean 80% of them will run in the direction of the overall trend. This is how we use it for sector analysis too. You might look at the S&P and it looks like it's getting a little ahead of itself but there may be a particular sector or something within the S&P that is showing these positive reversal patterns that say even though the overall sector or index is a little toppy and may correct, this looks like it's stronger.

So we're not judging relative strength to an index. We're using the RSI to measure the rate at which prices are changing against that particular issue itself. Some people get confused. They say, "Well, I know relative strength. Well, relative strength is how is that stock is performing against the S&P." It's a relative strength index that's saying what is this RSI showing as far as this particular issue relative to where it's been and where it’s going?

Tim Bourquin: Do you do a scan every weekend, every night, to find out which of the things and markets you're looking at are overextended?

Andrew Cardwell: The positions that I take are based on the general guidelines I have, like I mentioned, the range rules. I'm going to run a scan or a filter and say which stocks are in the above 40 RSI, have not been below 40 in, say, the last three to four weeks. I apply moving averages to the RSI to take out some of the volatility and say is this shorter term, in this case, the 9 above the 45 on RSI and I also use a 9 and 45 day moving average on close to identify first the trend. If I'm scanning for these or for these filters, then I have a list of which issues. And I'm primarily futures but I'm following currencies and cross rates—the indices, gold, silver, oil—anything that anybody is trading.

A lot of my trade ideas come actually from my course students. They'll send a chart to me and say, "Have you taken a look at coffee? Have you taken a look at cocoa? The range is shifting to the upside." So we can use the range rules as a scan or filter to identify those that should be an uptrend in this 80-40 range or ones that are in a downtrend between 60 and 40. I scanned quite often primarily two or three times a week just to look for potential set-ups to where the range rules are shifting. We've seen one of these positive reversal patterns that suggest something is ready to break out and take off to the upside or if the RSI is having trouble getting back above 60, being able to tighten up stops or take partial profits around divergences.

If a market has gotten a little bit overextended and we see a bearish divergence, we can tighten up the stock, we can take partial profits and let it correct and sell off into a new positive because the positives set the trend and they set a price target in the future, which is first resistance. But when it clears that price level, it confirms that the trend is still up in the case of a positive or down in the case of a negative. So it's not until we see a negative in an uptrend that we say it's reversed.

Tim Bourquin: What is RSI right now telling you about the overall market or maybe a favorite futures market that you're looking at right now that maybe is showing some good opportunities via RSI?

Andrew Cardwell: Well, they're all my favorites. Right now it looks as if stocks just around the election, and I'm talking in terms of the Dow and the S&P. Right in about mid-October you can look in an RSI chart and see that the RSI had been up above 70, about mid-September, and it sold off and then early October got barely above 60 up to about a 62, 63 and then in late October, mid-to-late October, it's not been above 60 cents. So we had a sharp selloff right after the election that took us down in the mid-November.

This just looks like a countertrend rally. I'm viewing it as an overall topping pattern. I'm very careful to—I've always been this way after 30 some years to come out and say something unless I've crossed my T's and dotted my I's. But you get a feel based on experience, based on trial and error over the years like I did to establish rules and patterns and everything. But I get a feeling right here, the way the charts are leaning, that this doesn’t have a lot more upside. It could be the fiscal cliff talk, the euro crisis, people worried about the tax structure, how much are they going to pay, what's Obama Care?

There's a lot of things crossing people's minds right now, which are creating a lot of short-term trading where people aren’t willing to hold on to anything. But I'm seeing a topping process that tells me that we're probably pretty close to a top and could sell off between now and the end of the year and something could last a while. So I'm leaning to the short side—not the short side but telling people to be protective, tighten up stops.

NEXT PAGE: A longer term outlook

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Longer term, I'm still a bull on gold. We were seeing range rules. We saw positive reversal targets. We were long from under 1200 all the way up. We had targets at 19 in the quarter to 1950. So when it got there, again, it got overextended. We've had some corrections. I think we sold off recently to an area of support in the 1675, 1700 level long term that I think is going to be the base for a move into next year that could carry gold back up to the highs that we saw before and exceed the highs. I actually expect to see 2250 to 2100 by maybe June of next year.

Currencies, still short the yen versus the dollar, long euro versus dollar. But I think the dollar is going to be strong for a while and gain on both the euro and the yen. So I think there's a lot of currency plays. I think there's a lot of market situations that are developing. We should see extend through the first part of the year. What's great, Tim, about being technical is—I did a webinar I titled Today's Technicals Write Tomorrow's Headlines. A lot of times a market will not move—it will move but we will not know why it moved on a fundamental or informational basis until a later point. But when we see that fundamental news and then we go back and look at the charts and say, "Why didn’t we see that?"

That's where I've been fortunate with the RSI, the range rules, the fact that I see a positive telling me a market has changed direction from down to up and that it's going to be moving up or I've seen it in an uptrend and get a warning that it's topping out. We don’t know the fundamental reason why it topped out until later. So I had one—John Murphy called me—it was John Murphy or Greg Morris—said I was a technician's technician, that I don’t read newspapers. I just look at the overall structure of a market to determine where I think it's going to go to.

Tim Bourquin: Yeah, you're one of the guys that feel like, "Everything I need to know is in the chart," right? "I really don’t need to follow anything else."

Andrew Cardwell: Pretty much. My wife says, "I think the charts talk to you. You get a feel for charts when you plot the RSI value each day. You don’t think one day is that significant, but you see that one point on a chart or on a graph with the RSI that—how it feels, how it fits, and how it's related to everything else on the chart."

Tim Bourquin: How long do your trades usually last when you're using RSI to find overextended?

Andrew Cardwell: Well, I've got some students and clients who—we put a trade and sometimes myself I've been in some trends for three months if it's a strong moving trend. But the beauty of the work is the fact that it doesn’t matter if you're using stocks, futures, currencies, cash, cross-rates and it doesn’t matter on the time frame. Welles defined—when he developed the RSI—it was a 14-period.

Well, I use 14-period on a monthly, weekly, daily, hourly, 15-minute chart, 5-minute chart. The rules don’t change depending on the temperament and investment objective of a trader. I have some traders that trade only in 5-minute charts, and they may make ten trades in a week. Some of them will make five trades in a day. My personal approach is what I called DH5—daily, hourly, 5-minute. I should see when a market is ready to turn.

All three time periods show basically the same thing. In other words, get a buy signal in each one of those time periods. But I can sometimes average three to four weeks in a trade. If a trade is very strong, something that I can see lasting a lot longer, I look at time cycles also—four weeks, six and a half, nine weeks. As long as with these positives I'm seeing these objectives met on the upside, see bearish divergence form, I take some profit, see a correction, add to the position.

So I basically trade in the direction of the trend as long as I'm seeing those objectives. Most of my reward, the risk ratios are three-and-a-half or four-to-one. So if I put a trade on a Monday and all of a sudden it moves too fast because quite often a market will make a low or make a high for trend change and you'll see an initial entry point. You get into the trade and two days later it's moved a lot more than you thought it would. So very quickly it gets overbought or overextended.

I'll sometimes take that tradeoff, let it correct back, and I'll probably enter a little bit higher than I did the first time. But when you look at a bar chart, you want to see a low, a secondary high or low, a third high or low that you can draw a trend line. You can draw all trend lines when your bar charts based on RSI values, which then become objective as opposed to subjective. You get a chart and put it in front of a couple of people. They could turn around and draw all different trend lines based on their biases.

Tim Bourquin: So RSI allows you to objectify that which is what you want because you don’t want your emotions to get involved in deciding when to trade. RSI kind of solves it for you.

Andrew Cardwell: Well, it keeps the emotion to a minimum. I've always used three keys to success I talk to people about when I give a presentation—methodology, patience, and discipline. The discipline to follow your rules, stay within your rules, control your emotions; and the patience to, as I quote, say allow the market to show you what it wants to do, not what you want it to do. Well, a lot of people force the issue. Nobody holds a gun to my head to tell me what to trade.

NEXT PAGE: A look at Andrew Carwell's upcoming New York Traders Expo presentation

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Tim Bourquin: Right. Well, and speaking of presentations, you did one at the recent Las Vegas Traders Expo. What kind of things—sounds like you talk about that. What else did you talk about in that presentation?

Andrew Cardwell: Well, I didn’t get to do a presentation in Vegas. I'll be doing one in New York in February.

Tim Bourquin: Oh, great. Even better. So people will be able to sign up for it.

Andrew Cardwell: Yes. I did an interview for the Website, Moneyshow.com, with Rob Booker. We were talking about that the RSI is much more than an overbought/oversold indicator, the fact that it incorporates price, momentum, time, sentiment, and the fact that most people look at it just as an oscillator and try and sell 70 and buy 30. It's more than just an oscillator. It's a trend following, trend identification approach with oscillators knowing when it's overextended taking profits. When it's overextended to the downside, watch for a bottom.

When I speak in New York, I'm going to speak specifically on that. That's the title of my presentation, Trend Analysis, Trend Change, and Price Forecasting. It's a very dynamic tool and very underutilized. People just pass it over and say, "Oh, that's just like any other oscillator. It goes between zero and a hundred. You sell it 70 and you buy it 30." If you're in a strong, strong downtrend, then when it gets down to your 30, if you start buying and it rallies and creates one of these negative patterns that suggests even lower, you'll say, "Well, I'll just buy more."

That leads to dollar cost averaging, which is a rich man's way to the poor house really because the market can go deeper in a downtrend than you have money in your pocket. When you think, "I can't take anymore," that's usually when the market made a bottom and turned up.

Tim Bourquin: All right. Well, great, well, listeners, you'll be able to sign up for Andrew's workshop that New York Traders Expo. Check it out at moneyshow.com.

Andrew, give us your Web site as well if people want to find out more about how you use RSI.

Andrew Cardwell: Yeah, I kept it real simple, cardwellrsiedge.com, because every trader wants an edge and the edge is to, first of all, be patient, control your emotions, and follow your guidelines, follow your rules, whatever trading program you have. Most people get too emotional, get too excited, and don’t follow rules. Your rules are what's going to keep you straight. I saw something that was very interesting. You know, Tim, before we talked I said I had to run out and I'll be back, I saw something on a sign at a church that said, "Practice makes perfect so watch what you practice."

Tim Bourquin: Makes sense especially in trading.

Andrew Cardwell: Yes. If you think about it, if you are constantly breaking your rules and you don’t change it, that's what you've created. I've taught students in my courses that I teach, golf is like trading. It's 80% mental and 20% psychological. You have a club in your hand, you swing the club, the ball gets in the way, and you're not hitting the ball. You're actually swinging the club but you just learn how to swing the club. If you break the rhythm or change something, you're going to see the effect of the direction of the golf ball.

Well, it's the same thing with trading. If you start to bend the rule—the worst thing a trader can do is be successful right out of the gate because then they think they did it on their own and they know what they're doing and the next time they're not following the rules. You have to have a trading plan. You have to have discipline. No one is going to be right every single time. Major league baseball players win batting titles batting 350. They're only getting 35 hits out of every hundred bats.

We're a trader. We go to the market, and we know we're going to try and make profits, we're going to take losses, but you have to be willing to admit when you're wrong because the most successful traders in the world are only right 30% to 40% of the time just like batting title. You're not going to hit a home run every time. You don’t try and hit a home run. Try and understand what the market is showing you.

I was very fortunate when I started working with the RSI, like I said, I've studied Elliott, I've studied Gann, I've studied so many different things. Even nowadays, Tim, I know you're not as old as I am, but when I started, everybody was basically fundamental and looking at profit earnings and ratios. I started looking at charts, and I was fortunate I've had somebody show me the RSI or share the RSI article with me. It can be a complement to anything else you're using. It can stand as an independent trading model, and that's what I've taught my students in my courses.  

I have some Elliotticians that are great Elliotticians and they tell me that it helps them to understand wave structure. I have some who study basically Fibonacci patterns and they say what you've shown in your range rules when I see a certain range being tested like the 40 and it should be support then it complements what I'm doing in my Fib work.

So I've been very fortunate to meet a lot of people over the years through my courses and I've tried to teach them what I taught my son when my son and his friends were playing Little League and I was a baseball coach. The better you learn to play a game, the more fun the game will be.

Tim Bourquin: Andrew, thanks very much for your time today. I really appreciate it. Listeners, you can go to Andrew's website and check it out there. Andrew, we will see you in New York.

Andrew Cardwell: I look forward to it, Tim, and it was great to see you in Vegas when we did. We'll see you up in New York City.

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