Technical Analysis

Extream Levels

One should understand that an overbought or oversold position can remain in an extended uptrend or downtrend for some time. When in a particularly bullish or bearish trend, the top and bottom levels should be adjusted, as the market may have some upward or downward bias during these times.

• During a very bullish phase, 80 can be used to identify an overbought currency.
  
• During a very bearish phase, 20 can be used to identify oversold levels.
• In Forex, a technical trader may also need to adjust the 70/30 levels when using RSI with very short time periods.

Extreme Readings as Entry Points:

Another technique some technical traders use is to identify the long-term trend of the currency and then use the RSI to help find entry points. This involves getting into either a bullish or bearish rally during a time when the currency is overextended in the opposite direction of the trend. make .

• If the long-term trend is Bullish, then oversold readings could mark potential entry points.
• If the long term trend is Bearish, overbought conditions make good entry points.
  

Extended Showings at Overbought Level:

Example: The Euro vs US Dollar, October ‘04 – Jan ‘05.

From November ‘04 through December ‘04, RSI touches and stays above the 70 oversold level for more than a month.

a. Traders should watch the volume indicator in the instances when the RSI has an extended showing either at the 30 or 70 levels.
b. This helps the technical trader determine if the interest in the rally is continuing or waning. Traders may decide to take profits as the pair becomes overbought.

1. On Oct. 20th, RSI goes above the 70 overbought level for the first time. Even though the pair is measuring overbought on the RSI indicator, price does not reverse, and until Nov. 10th it gradually climbs up. Something on the fundamental side during this time must have kept investors and traders buying Euros over the Dollar.

2. After the 10th, volume picks up dramatically as investors continue showing interest in the Euro rally, pushing the Euro higher until Dec. 3rd. Throughout this time RSI measures either at or above the 70 level.

3. On the 3rd, volume, price and RSI drop down.

a) These are signs that the uptrend is weakening.
b) Some might be inclined to sell Euro right now and take profits (and for a week this seems to be what happened).
c) The Euro rallies from this sell off, but without the high volumes seen before.

The week before the New Year shows the rally stalling as RSI hits the 70 level again. Finally we have reached the market top. There is even a bearish divergence signal (explained next) at play here. If a technical trader was savvy enought to read the weakining interest in the rally, and to see the bearish divergence, he would be inclined to sell now.

The market top is followed by a steep 500 pip fall in the Euro. 

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