Key Takeaways
- True Strength Index (TSI) is a momentum oscillator used to determine market sentiment and potential reversals.
- The TSI oscillates between positive and negative regions, indicating bullish or bearish conditions respectively.
- Divergence between TSI and price may signal an imminent reversal.
- A TSI crossing above its signal line is typically viewed as a buy signal, whilst crossing below is seen as a sell signal.
- The threshold for overbought or oversold conditions can vary depending on the asset.
Formula and Calculation
The TSI is calculated through a double smoothing process of daily price movements, both absolute and relative. Here’s a breakdown of the formula:
TSI = (PCDS/APCDS) x 100
Where:
- PC = Price Change = Current Close Price (CCP) - Prior Close Price (PCP)
- PCS = 25-period EMA of PC
- PCDS = 13-period EMA of PCS
- APC = Absolute Price Change = |CCP - PCP|
- APCS = 25-period EMA of APC
- APCDS = 13-period EMA of APCS
The challenge lies in the ability to adeptly compute the Exponential Moving Average (EMA), ensuring accuracy in the TSI’s predictive capabilities.
How the TSI Works
Introduced by William Blau in 1991, the TSI helps analysts gauge the momentum and strength of a security’s price. The index provides insights into overbought and oversold conditions, facilitating predictions about future price movements.
Crucially, the TSI’s sensitivity to price changes enables traders to identify subtle shifts in market momentum, which can prelude significant price reversals. It’s effective across various assets, but analysts must adjust overbought and oversold thresholds according to specific market conditions.
Practical Trading Tips
- Monitor TSI Divergence: If TSI diverges from the price trend (i.e., price rises while TSI falls), consider this a strong reversal signal.
- Signal Line Crosses: Buy when TSI crosses above the signal line; sell when it crosses below.
- Set Appropriate Thresholds: Adjust overbought and oversold levels based on historical performance of the asset.
Related Terms
- Momentum Oscillator: A tool that uses the velocity of price changes to identify the strength of price movements.
- Exponential Moving Average (EMA): A type of moving average that places a greater weight and significance on the most recent data points.
- Market Sentiment: Bulls and bears duke it out – understanding their mood swings can be crucial!
Suggested Further Reading
- “Momentum Indicators” by Martin J. Pring: Delve into various momentum indicators that can aid in trading decisions.
- “Technical Analysis Explained” by Martin J. Pring: A classic resource that provides a thorough overview of trading practices including TSI.
By understanding and utilizing the True Strength Index, traders can elevate their market analysis and better navigate the complexities of various financial landscapes.
