Baeyens, Walter - RSI Logic, Signals & Time Frame Correlation.pdf

RSI
LOGIC, SIGNALS & TIME FRAME CORRELATION
Walter J. Baeyens

Copyright 2007 by Traders Press, Inc.® All rights reserved.
Printed in the United States ofAmerica. No part ofthis publication may be reproduced
ortransmitted in any form orby any means-e 1ectronic, mechanical, photocopy, recording,
or otherwise-without written permission ofpublisher.
ISBN 10: 1 -934674-00-1
ISBN 13: 978-1 -934674-00-0
Edited by Roger Reimer and Shelley Mitchell
Layout andcoverdesign by Shelley Mitchell
Contactus:
(800) 927-8222
Published by Traders Press, Inc.®
PO Box 6206
Greenville, SC 29606
www.traderspress.com
(864) 298-0222
customerservice@traderspress.com

Publisher's Foreword
TIrree decades ago, Welles Wilder, atrue pioneer in the art of technical analysis,
developed RSI, the topic of this book. RSI has become one of the most popular and
mostwidely used technical indicators available and is found in virtually every technical
analysis software program. It has been my honor and privilege to have met Welles
shortly after the publication of his groundbreaking book, "New Concepts in Technical
Trading Systems" in 1978, and to have been his friend since. Traders Press has had
a longstanding business relationship with Welles' company, Trend Research, and his
original work on RSI continues to this day to be a popular and highly sought after
book, which is distributed by Traders Press.
Walter Baeyens, a Belgian trader, has developed his own take on the most
effective way to use RSI in making trading decisions, which he shares in this, his first
book. It is our hope that by sharing with the reader the benefit of his own research and
work, this book will prove educational and beneficial to you in your own trading.
Edward D. Dobson, President
February 22, 2008
Traders Press, Inc.
Greenville, SC

Publisher's Dedication
Traders Press, Inc. proudly dedicates this book to
WellesWilder, the originator and "inventor" of RSI.
Welles Wilder and Edward Dobson in Greenville, SC circa 1990.
Wilder is an avid collector of antique cars and this photo was taken
when he visited Greenville and displayed his collection at an auto show.

RSI:
LOGIC, SIGNALS & TIME
FRAME CORRELATION

Contents
Chapter One: Old Myths and New Concepts
PartI:Getting Started . . . . . . . . .. . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . .. . . . . ... 19
PartII:TheRSIHalf-pipe. . ............. . . . . . . . . ... ........ . . . . . . . . . . ....... J)
Part III: A Small Dose ofRSI Mathematics. . . . . . . . . . . . . . . . . . . . ........... 21
PartIV:TheOldMyths. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .... Z3
PartV:NewIdeas. . . . . . . . .. . .. . . . . .. . . . . . . . . . . .. . . . . .. . .. . . . . .. . . . . . . . . . . .. . .. �
PartVI: TheCardwellian Signals. . . . . . ...................................... 34
Chapter Two: The Slanted RSI Universe
PartI:TheRSIDistortion. . ................................................. if!
PartII:RSlZOOm-in. . . . . . . . .. . .. . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . .. 51
Part III:RSI Segmentsand Channels. . . . . . . . . . . . . . . . . . . ................. 53
PartIV:RSIChannelLogic. ......... .......................................... 57
Part V:The Nature ofPriceI RSI Divergences. . . . . . . . . . . . . . . . . . .......... 67
PartVI: RSI Signals Revisited. . .. . .. . ... .. . .. . .. . .. . .. . .. . ... .. . ............. 72
PartVII: TheRSILighthouse. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 81
Part VIII: (DD)-Based Support and ResistanceLines. . . . . . . . . ........ 83
PartIX: Validityof(DD) Signals. . . . . . . . .. . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . �
PartX:FAST(DD) Signals. . . . . . . . ... . . . . . . . . . . . . . . . . . . . . . . . . . . . .............. &5
PartXI: Patterns intheRSL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . a:>
PartXII:UseofRSI(3). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. g.)
PartXIII: Practice. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .............. 104
Chapter Three: RSI Time Frame Correlation
PartI:Introduction. . ......................................................... III
PartII:Basis ofTime Frame Correlation. . . . . . . . . . . . . . . . . . . . . . . . . . . . . .... 1 13
PartIII:Failureof(DD) Signals. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . ... 1 15
Part IV:TFC-Zooming-in, Zooming-out. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121
PartV: Identical Signals in DifferentTime Frames. . . . . . . . . . . .. ......... 125
Part VI:Conflicting Signals in the Same Time Frame. . . . . . . . .......... 1�
Part VII:Conflicting Signals in Different Time Frames. . . . . . . . . . . ... 134
Part VIII: Projected Price Targets Revisited. . . . . . . . . . . . . . . . . . . . .......... 161
Chapter Four: Additional Thoughts and Tools
Part I: RSI Combined with Other Technical Analysis Tools. . . . . . . 187
Part II:Practical Guidelines - Plotting RSI Channels. . . . . . . . . . . . . . . . 198
Chapter Five: Real-Time Application
PartI:DrugIndex($DRG X). . . . . . . . . . . . . . . . . . . . . . . . . . .. . .. . .. . .. . .. . .. . .... 215
PartII:CrudeOilFutures (CL)·· . .· . . · ..· . .· . . · . .· . . · . . · . . · . . · ..· . .·
.. · ..··267
PartIII:S&P 500Index. . ....................... ............................. 302
PartIV
:NVIDIA(NVDA). . .. . .. . . . . .. . .. . . . . .. . .. . . . . . . . .. . .. . . . . .. . .. . ..... 325
Appendix 1: References and Recommended Reading. . . . . . . . ........................ 342
Appendix 2: RSI MovingAverages Fonnula for TradeStation. . . ................ 343
Index. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .............................. 344
All charts created on TradeStation®, flagship product ofTradeStation Technologies, Inc.

PREFACE
How could I ever forget October, 1 9 1 9817 It was the day I fell in love with technical
analysis! I had started to study the financial markets a few weeks earlier, looking for an
opportunity to make some extra money. Back then, the internet did not exist, so most
of the information I could gather came out of The Wall Street Journal. In the week
leading up to the 1 987 stock market crash, I decided to buy some Put Options.
My decision was based on what I had learned about the interpretation ofthe Relative
Strength Index, or RSI, which lookedpretty straightforwardto me. Then, Black Monday
was upon us. On that day, making money never looked easier. I could not believe my
eyes as I watched the live pictures from Wall Street. I was making money by the
minute, having a hard time keeping score as my Put Options' value literally exploded.
Just watching the markets go my way and being on the right side gave me a powerful
feeling. I was addicted!
I had neverexpected it to be so easy and, more importantly, it seemed that I was holding
the key to further gains. My key was the magnificent RSI that had served me so well.
Looking back, these are sweet memories! I must conclude that this small victory over
the markets involved more luck than skill. Let's just call it "beginners' luck." All things
considered, when I say that I based my trading decision on RSI analysis, I should add
that I was merely following the RSI guidelines published in some popular books and
articles that were available at that time. Did I really believe that the path to easy
success was paved with piece-of-cake RSI analysis? Unfortunately, I did.
You have probably already guessed whathappened next. In the months and years that
followed my initial "brilliant move" on Wall Street, I lost most ofthe easy money. The
losses left me puzzled and disappointed, because I had been stubbornly acting on the
RSI signals that I believed had correctly triggered my bearish profits back in October
1987. Still, while feeling dupedby the obviously misleading publications I had studied, I
remained convinced that the RSI had much to offer, if I only knew how to read it
correctly. And so, I started my own search for alternative views on the RSI and new
methods ofinterpretation. Still I remained convinced that the RSI had a lot to offer, if!
only knew how to read it correctly. And so I started my own search for alternative
views on the RSI and for new methods ofinterpretation.
The Relative Strength Index was introduced by J. Welles Wilder, Jr. in 1 978 in his book,
New Concepts in T
echnical Trading Systems. Wilder had been looking for a way to
detect oversold and overbought conditions in the market. Great idea! It would be
fantastic to have a tool that tells you when the market reaches absolute oversold or
overbought conditions. Such a tool could accurately pinpoint trend reversals; the only
requirement would be to take alternating positions in the market as it went through
consecutive overbought and oversold conditions and rake in the profits.

Unfortunately, Wilder did not create an Absolute Strength Indicator. He developed the
Relative Strength Index (RSI), which does not signal absolute overbought or oversold
conditions. The RSI merely quantifies actual market conditions relative to earlier
conditions within a given time period. Over the years, the RSI has become immensely
popular with professional and private investors and traders. But could I find a way to
use it profitably? Fortunately, as the immense data resources became available on the
internet, it was not long before I discovered some interesting alternatives for the Wilder
interpretation ofthe RSI.
The method taughtbyAndrew Cardwell caught my attention. It complements Wilder's
method and sheds a new light on how to put the RSI to work in a profitable way. Based
on Cardwell's inputs, I found a way to advance and develop a new logic for the
interpretation ofthe RSI by redefining the signals, as well as the limits oftheir validity.
Most importantly, I was able to introduce the concept ofTime Frame Correlation, adding
an extra dimension to the RSI toolbox.
Today, technical analysis has become an industry in its own right. When surfing the
internet, thousands ofwebsites are available offering software, books, recordings, courses,
consulting services and conferences on the subject of technical analysis and trading
strategies. To my amazement I find that when discussing the use ofthe RSI, none of
the publications refer to Cardwell's rules ofinterpretation, which is a pity.
In this book, I have condensed most ofthe relevant information that took me so long to
gather from the early Wilder rules to the useful Cardwell rules and beyond, to my own
RSI Channel interpretation with Time Frame Correlation insights.
Is technical analysis worth the effort at all? Ifthis question means "can market moves
be predicted," the answer is: yes and no! When I say that starting tomorrow, the
markets will move up, down and sideways, I make a valid prediction that will surely
come true. But that does not say much, does it?
Some people will say that the markets are moving "randomly." It is not always clear
what this means either. In his book Fooled by Randomness (Thompson, NY), Nassim
N. Taleb tries to convince us that market analysis is ofno use because price action is
random. However, it has been documented that patterns appear in statistical data
describing selected, obviously random events. For math lovers, I refer to the "Arcsine
Law" theory in respect ofthe random-walk properties ofthe fmancial markets.
Contrary to Taleb's, my conclusion is: Ifpatterns emerge, the study ofthe events under
examination, whether you label them"random" ornot, should include the study ofthose
patterns. The kind ofrandomness that never generates any patterns at all is very hard
to come by, as any cryptology expert will confirm.
The "random vs. predictable" issue reminds me of the "determinism vs. probability"
discussion in Physics and Philosophy. One may look at the issue in this way: Ifyou start
with enough dice players, you will end up with a dicer who rolls double-sixes ten times
in a row! That is deterministic; it is bound to happen as determined by the laws of
statistics. That particular person who is the winner ofthe contest may rightly consider

herselfjust extraordinarily lucky because any of her co-players could have hit that
mark, which defines randomness.
So it looks to me like randomness and predictability are complementary, rather than
mutually exclusive depending on your definition of those concepts. If randomness,
chaos, the efficient market, game theory, prisoner dilemmas, orhoweveryou choose to
qualify market action generates patterns, we may profit from studying them.
Some will argue that studying an indicator such as the RSI is useless because it merely
repeats price information and expresses it in a different form.
It is certainlytruethatthe "ultimate reality" in technical analysis is price. Sure, we start
with price data and study it in order to draw conclusions about probable future price
behavior scenarios. But ifprice is the ultimate reality to be studied, why not look at it
fromvarious angles? When scientists attempt to define theproperties ofan object, they
put it through all kinds oftests, observing its behaviorundervarious unusual conditions.
Each one ofthose testsrevealsa certainaspectofthe object's "reality" and this knowledge
enables the scientists to anticipate the object's behavior under varying conditions in the
future. In my opinion, putting price data through a mathematical equation, such as the
RSI formula, allows us to examine a relevant (but usually hidden) aspect ofprice reality
that would otherwise remain undetected.
So yes, I do indeed believe that technical analysis beats flipping coins when it comes to
profiting in the financial markets. In the following pages, after having reviewed the old
rules and insights, I aim to demonstrate that the best way to analyze the RSI is to
examine its behavior in relation to its channels in various time frames and to correlate
these pictures.
I hope that my book contributes to a better understanding of the RSI and that it will
offer an extra tool to analysts, traders and investors who are willing to put in the effort
to assemble the RSI puzzle.

CHAPTER ONE
OLD MYTHS AND NEW CONCEPTS

PART I
GETTING STARTED
We need a tool that will provide a workable hypothesis about market behavior in the
near future. This hypothesis would include market direction, timing, price target(s) and
the probability ofthe scenario becoming a reality. The tool should also provide an early
warning when it turns out to be wrong, so losses can be limited. The Relative Strength
Index is such a tool. It allows us to enter the market with confidence, determine the
risk/reward ratio, exit positions early ifthe hypothesis is wrong (taking a small loss) or
ride the market to a target price and beyond when the hypothesis is right.
1. Welles Wilder, Jr. developed the Relative Strength Index as a tool to detect overbought
and oversold conditions in the market. To do this, he compared the average up and
average down price movements within a given period oftime in the past. The look-back
time window favored by Wilder for the calculation ofthe RSI values was 1 4 periods.
Consequently, themethod described inthisbookpertains to 14-period RSI data calculation,
using closing prices. This means that no conclusion should be drawn from an RSI signal
until the closingprice is in. Although this seems to be common sense, in the heat of
trading, one is often tempted to act prematurely.
The RSI charts in this book feature the same 14-period setting, except where mentioned
(some charts only cover 3 periods). Each market has its own peculiarities but, generally
speaking, my RSI analysis method is applicable to all kinds ofmarkets, including stocks,
futures, currencies, treasury bonds, interest rates and indices in all time frames.
A word of caution: In very short time frames, the RSI is volatile, frequently hitting
extreme highs and lows and generating contradicting signals in rapid succession. Also,
if the overnight sessions in futures markets are not plotted, the RSI readings at the
opening ofthe regular session may look irrational in the short time frames because of
the overnight gap in RSI data.
In flat markets, the RSI will generate signals while prices go nowhere. It is important to
avoid getting caught during lackluster lunchtime trading periods or overnight sessions.
For RSI signals to work in terms of anticipated price action, there should be some
degree ofprice action momentum and volatility in the market.

Walter J. Baeyens
·3m OlE l-1370.50 -2.00 -0.15% 8-1370.50 A-1370.75 0-1372 75 374.00 C-1370.50 V-29746
1:00 2:00 3:00 4;24 5:45 7:27 8:27 9:24 10'21 1U8 e 1 3:15 14:12 15:09 16:06 11:03 18:00 18:57
IAI
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Created WIth TradeSlation
Figure 1.1 S&P Futures Overnight (3-Minute)
After 14 periods, the RSI starts fluctuating between 30 and 70, while prices go nowhere.
PART II
THE RSI HALF-PIPE
Watching RSI fluctuations on a chart is like observing a skater going up and down in a
half-pipe. Imagine looking at the skater from a bird's viewpoint, high above. From this
perspective, the half-pipe looks like a flat, rectangular metal surface and the skater
goes back and forth between the top and bottom edges. The half-pipe is the RSI chart,
and its extreme values of0 and 1 00 are the edges where the skater seems to be suspended
before accelerating down the slope in the opposite direction. The skater's speed is
highest in the middle ofthe half-pipe. As he zooms upward on either slope, his speed
slows dramatically, then drops to zero as his course reverses.
Due to the mathematical constraint of being squeezed into a range of 0 to 1 00, the
distance traveledby the RSI in its chartis not directly proportional to the change in price
that caused the move, as it is a logarithmic function. In fact, just like the skater in the
half-pipe, the RSI has its greatest velocity when crossing the middle ofthe RSI chart at
the RSI 50-line. It will rapidly and increasingly slow down when approaching the upper
and lower edges ofthe chart.
20

RSJ: Logic, Signals & Time Frame Correlation
In practice, a relatively small change in price can cause a big move in the RSI value
when it travels around the 50-level. However, large price changes arerequiredto move
the RSI value a little, once it approaches the extremes, as ifan ever-increasing momentum
were required to push it up an increasingly steep slope.
The values where the Relative Strength Index runs into rapidly increasing resistance
are the 66.6 and 33.3 levels. In fact, this behavior is a consequence ofthe nature ofthe
RSI equation itself, designed to limit the course ofthe RSI within its 0 to 1 00 range.
In other words, a small move in the RSI value, when it is near extreme levels, corresponds
to a relatively big move in price!
PART IIJ
A SMALL DOSE OF RSI MATHEMATICS
When studyingthe RSI(14) - meaning the RSI takes into account a 14 period look-back
window ( 1 4 days in the daily charts or 1 4 minutes in the I -minute chart) - we are
looking at the Relative Strength (RS), expressed by the price ratio:
Average UP (on close)over last 1 4periods
Average DOWN (on close) over last 1 4 periods
This ratio is pressed into a 0 to 1 00 scale by the following formula:
RSI = 100 - ( 1 00 / l +RS)
Ifall oftheclosingprices hadbeen UP overthe given period, the RSI would rapidly rise
to 1 00, since the ['RS'] would tend to be infinite causing the [(1 00 / l +RS)] to tend to be
zero.
As such, this makes the equation unsuitable for use because the resulting RSI values
will be higher for a slow (but uninterrupted) price rise than for a strong price rise that
suffers the occasional down retracement.
In order to avoid this effect, the Welles Wilder approximation system was adopted.
Instead of taking each of the 14 UP or DOWN values of the look-back period into
account, Wilder resolved to take the average UP or DOWN ofthe last 1 3 periods. This
value was multiplied by 1 3 and added to the value UP or DOWN ofthe most recent
period number 14. Then, this sum was divided by 1 4. This calculation also made the
daily manual RSI calculations much easier to manage as today's value was added to the
latest average and the new value was divided by 14.
21

Walter 1. Baeyens
For an RSI(1 4) calculation using daily data, the RS equation shown above is changed
and the values for the Average UP and Average DOWN are calculated as follows:
UP=[(Average UP last 1 3 days) x 1 3] + Value UP today
14
DOWN =[(Average DOWN last 1 3 days) x 1 3] + Value DOWN today
14
The fact that the value of the first day ofthe RSI(14) analysis is based on the average
ofthe 1 3-day period preceding that day means that today's RSI calculation, to a certain
extent, incorporates daily data older than 14 days. This method ofcalculation smoothes
out the RSI and eliminates the unwanted tendency ofthe RSI to move to extremes after
14 periods ofuninterrupted price increases or declines.
Consequently, a time span covering a minimum of 1 5 times the look-back period needs
to be observed in order to obtain reliable RSI values. This means that for an RSI( 14)
daily study to be reliable, at least 2 1 0 days ofdata need to be available.
The RSI Ratio Table
For a given look-back period, when the UP Average equals the DOWN Average in the
RS calculation, the RSI will display a value of 50 as the ups and downs balance.
When the balance shifts in favor ofthe UP or DOWN Average, the RSI value will rise
or fall, but not in a directly proportional or linear manner.
The following table shows the UPIDOWN ratio required to move the RSI to the displayed
values:
RSI=90
RSI=80
RSI=75
RSI=66.6
RSI=50
RSI=33.3
RSI=25
RSI=20
RSI=10
UP/DOWN= 1 0 / 1
UP/DOWN=4 / 1
UP/DOWN =3 / 1
UP/DOWN=2 / 1
UPIDOWN = 1 / 1 NEUTRAL BALANCE
UP/DOWN= I / 2
UP/DOWN= 1 / 3
UP/DOWN= 1 / 4
UP/DOWN = 1 / 1 0
This table clearly illustrates that the RSI value meets increasing resistance when
approaching the extreme values of0 and 1 00. A rise of 1 0 points in the RSI from 75 to
85 must correspond to a price move UP that is much more significant than a price move
UP corresponding to a 1 0 point RSI move from 50 to 60. The half-pipe effect in the RSI
becomes clearly visible above the 66.6 level and below the 33.3 level, where the RSI
must travel ever-steeper slopes.
22

RSI: Logic, Signals & Time Frame Correlation
PART IV
OLD MYTHS
Now, for the sake ofcompleteness we are ready to look at the initial RSI rules. I am
sure that you are already familiar with some ofthem, as they keep appearing in many of
the present-day technical analysis manuals and websites.
Here is what I learned back then. The main RSI signals, we were told, were:
The RSI hits or exceeds values of70 or 30, signaling overbought and oversold
conditions respectively.
Divergence between price and the RSI signals imminent trend reversals.
The RSI crosses the 50-line up or down, meaning the market turns bullish or
bearish.
The swing failures, meaning the RSI reverses course.
Let's have a closer look at each one ofthese points.
Overbought and Oversold Levels
As demonstrated earlier, the mathematical resistance of the RSI is a built-in feature
that takes effect around the 66 and 33 levels. This means that more often than not, the
Relative Strength Index value will have a hard time moving past these levels. But does
this justify the conclusion that these levels signal the market trend is exhausted?
We know that a tiny movement in the RSI value, when it is over 66 or under 33,
corresponds to a relatively large move in price. This means that at the RSI 70-level, the
best may be yet to come in a strong uptrend. This is not in terms of further important
jumps in the RSI value, but in terms of prices moving up strongly. Conversely, in a
downtrend there is a huge down potential for prices while the RSI value is below 33!
Also, in my view, any claim relative to RSI signals should specify from which time
frame the signal is taken. Imagine that we have been in a strong uptrend for the last five
trading days. Would it make sense to determine that this rally is coming to an endjust
because the RSI hits the 70-level in a I 5-minute chart? In reality, the I 5-minute RSI
will hit the 70-level several times a week in a rally ofsome magnitude.
When the I 5-minute RSI reaches the 70-level, the RSI value on the daily chart may be
at 60, with plenty ofUP potential. We may be tempted to assume the daily time frame
was the main object ofWilder's research, but it is clear that we will need to find a way
to correlate the various RSI pictures. It is not hard to imagine the following scenario:
The RSI hits 30 in the daily time frame, allegedly signaling oversold conditions, while the
weekly RSI may be at the 40-level, suggesting there is still a distance for the market to
go on the downside.
23

Walter J. Baeyens
From this illustration, it becomes clear that RSI levels signal different things when taken
from different time frames. Hence my conviction that any conclusion drawn from a
given RSI picture will be incomplete unless it is correlated to other time frames.
What should be made of Price/RSI divergence? Imagine that the daily RSI hits 75.
According to Wilder, this would indicate that the rally is about to end, while prices
continue to hit new highswiththe RSI meanderingtothe downside. (This is the definition
ofPriceIRSI negative divergence). In this example, some will say the RSI worked off
its overbought condition. However, since prices kept rising, there really never was an
overbought condition.
There is no such thing as an overbought or oversold RSI and there are no such things as
absolute overbought/oversold price conditions. In fact, there are plenty ofexamples of
up-trending markets with major pricejumps taking the RSI well above 70, even in the
weekly time frame. In bear markets, you will often see prices accelerate their slide as
the RSI value appears to be locked down below 30 for an extended period oftime.
My advice: Do not let the 70 and 30 RSI levels fool you into initiating countertrend
positions; it needs to be put in the correct perspective.
.Weekly NYSE loo86.08 +1.36 +1.63% 8=85.20 Aa86.05 0=84.45 1i;86.21 l0a84.44 C..as.DB V-7788600
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Figure 1.2 IBM Weekly
This weekly chart shows a strong rally in IBM from 1996 to 2000. I have drawn a
horizontal line at the 70-level. If we had blindly applied the Wilder rules for RSI
interpretation, we would have sold IBM in Quarter 1 of 1 996, when the RSI reached
the 70-level. But look what happened after that. After a mild drop into mid- 1996, the
24

market rallied and the RSI reached the 80-level by the end of 1 996. Prices continued to
rise, while the RSI peaked well above 70 several times in 1 997 and 1 999. The fact that
the RSI never dropped below 40 until Quarter 4 of 1 999 is typical ofsuch a strong rally.
This chart is not exceptional. There are plenty ofexamples that show the RSI exceeding
70, after which the rally continues and strengthens. I believe it is closer to the truth to
say that the rise ofthe RSI above 60 is typical ofthe start ofa rally than it is to say that
the RSI reaching 70 signals the end ofthe rally.
RSI/ Price Divergence
Price/RSI divergence provides another source of confusion. Many mainstream
publications about the RSI tell you that this kind of divergence signals the end of the
current trend. Some even list divergence as buy and sell signals!
Unfortunately, as simple and as good as that may sound, divergence can be a misleading
interpretation and (as far as I know) no one has offered any satisfactory alternative
views.
Missing here is the specification ofthe time frame reference when trying to anticipate
what PricelRSI divergences will cause in the longer run. All ofthis talk about divergence
makes them look special, but they are not. They occur frequently because they are
inevitable; thus we should not search for any magical properties here.
After the initial trend pushes the RSI to its limit, given the significantrelative increase in
momentum in the recent past, the RSI flattens out or even declines, simply because the
rate of increase in momentum is decreasing, while the trend keeps going. More than
anything, the existence ofPriceIRSI divergence confirms the present trend. Look at the
evidence.
A negative divergence occurs when price reaches a new high, while the RSI only
makes it to a lower high. By definition, when prices hit new highs, we are looking at an
uptrend. Apositive divergence occurs when prices hit lower lows, while the RSI values
already rise, hitting higher lows. By definition, when prices reach lower lows, we are
looking at a downtrend. So, an interesting point about Price/RSI divergences is that
negative divergence occurs only in an uptrend and positive divergence occurs only in a
downtrend. Obviously, this statement is an oversimplification, but should be included
because this is how Andrew Cardwell treats divergence in his Trend Determination
Checklist. He sees divergence as one of several symptoms accompanying a trend. It
says that the market is in an uptrend as long as there are higher highs in price. To that
I would add: That is correct, whether or not there is a negative divergence. In other
words, do not worry about negative divergence until you see lower highs in price.
Divergence occurs frequently and it does not have any special significance.
I like to think of Price/RSI divergences as follows: In a strong downtrend driven by
longer-term traders that continues for several weeks, the RSI value in the hourly charts
will be propelled down below the 30-level in a matter ofdays. But the price decline is
far from over. What happens next? The RSI value is pushed even lower, let's say to the
25

Walter J. Baeyens
I S-level. But the price drop is still not over. The daily RSI value drops below the 38-
level and appears to have further to go. Then what happens? The hourly RSI, at some
point, hits its minimum value, meaning the maximum momentum ofthe decline is unable
to push the RSI down any further. Remember the extraordinary down/up ratio that is
required (in the last 14 hours) to push the RSI below the 20-level and the 1 0-levei.
The RSI is being compressed at the bottom of the hourly chart, but the price drop
continues (let's say that the daily RSI reaches 32). The hourly RSI has nowhere to go
but up, as down momentum in relative terms is not increasing sufficiently to depress it
further. Consequently, the RSI starts to curl up in the hourly chart, while prices continue
their drop.
We will treat RSI divergence in accordance with the general rules that will be defined
later, meaning they need to be understood as a particular RSI behavior within RSI
channels.
C80E L-S95.45 +7.96 +1 .36"- 6-594.94
Created WIth Tr�St"oo"
Figure 1.3 Daily Oil Index
In this Daily OIX (Oil Index) Chart, there are two positive divergences. The first one
starts at Point I in the RSI chart. While prices reach a new low in October 2002, the
RSI has been rising since August. It is clear that this positive divergence does not lead
to a rally, as prices resume their decline in January 2003, without exceeding the last top
ofOctober 2002. What follows is a lower low in price in January 2003.
The second positive divergence starts at Point 2. This time it persists long enough to
lead the RSI within its ascending channel into bull territory and the appearance ofa buy
26

signal by the end ofMay, signaling the start ofa rally. The bullish signal in the RSI is
marked by the acronym (DD+) within the ascending RSI channel.
Ooiy CBOE L-S95.4S .7.96 .U6% 8-5"'.'" A-595.64 00587.47 fIoS99.B3 Loo567.47 00595.45 yo{)
In this chart, the point of interest is the negative divergence between price and RSI in
the period between Points A and B. Here we see prices reach consecutive higher
highs, while the RSI from PointsA' to B' declines. Note the rapid price rise into PointA,
corresponding to the initial price thrust and steep increase in momentum, causing the
extreme RSI reading at Point A'. This reflects the high rate ofchange in momentum in
the recent 14-day period. PastPointA, any momentum change will be compared to the
high earlier values in the recent past, hence the decline in the RSI value despite the
continuation ofthe rally.
Still, the negative divergence does not lead to a trend reversal to the downside. Quite
the opposite happens, as prices continue their rise past Point B. Again, it is not hard to
find many more examples where a negative divergence does not lead to the beginning
of a bear market phase.
Price/RSI divergence is not an exceptional signal. It occurs frequently, as it is inevitable,
and does not warrant any special treatment. It is just one way for the RSI to escape its
mathematical constraints.
27

Walter J. Baeyens
The RSI 50-Line
The 50-level in the RSI value signals a balance between price moves up and down
within the 14-period look-back window. This leads some people to think when the RSI
crosses the 50-line to the upside, the market must be turning bullish, and when the RSI
drops below the 50-level, the market is turning bearish.
From our earlier discussion, you already know that this rule is too simplistic. Again,
there is no specification about the time frame from which this RSI reading is taken. It is
possibleto seethe hourly RSI drop belowthe 50-level whilethedaily RSI value is at 60.
The RSI around the 50-level sometimes shows evidence ofthe indecision in the market.
Such is the case when the RSI is oscillating in smaller moves above and below the 50-
level, building an RSI triangle that is often centered on the 50-level. The corresponding
price action features either a narrow trading range or the formation ofa price triangle.
This RSI behavior illustrates the indecisive fight between equally strong bulls andbears
in that particular time frame. At some point, the RSI breaks out ofthe triangle one way
or the other. The RSI triangle is an interesting pattern to watch for, as it indicates a swift
move in both the RSI and price in the near future.
Failure Swing in the RSI
Failure swings occur whenthe RSI dropsbelowthe level ofthe trough in an M-formation
or when the RSI rises above the level ofthe peak in a W-formation. These signals are
more significant when they occur within the oversold « 30) or overbought (> 70) zones
ofthe RSI chart. The general consensus is: these conditions are met, a price correction
is imminent. There are problems with this theory.
First, when comparing different points on the RSI graph, the relevant reference lines
arenot horizontal lines (such as the 70-level or 30-level lines) but slanted lines, defined
by the upper and lower boundaries or their parallels ofRSI channels.
Second, the failure swing, especially near the extremes ofthe RSI chart, often leads to
the start of a Price/RSI divergence. This means that after a failure swing down has
occurred, the RSI often continues downwards and rebounds off of a lower low, while
prices continue going up. After a failure swing up, especially near RSI extremes, the
RSI maycontinue upwards, while pricesjust keep falling, defining apositive Price/RSI
divergence.
In later chapters we will learn that these failure swings may be relevant if and when
they coincide with particular RSI reversals, namely those that cause the formation of
bullish or bearish signals, labeled (DD+) and (DD-).
28

PART V
NEW IDEAS
New RSI Realities
Let's leave the RSI world as described by Welles Wilder and examine some new ideas
brought forth by Andrew Cardwell. Cardwell, who acknowledged the inherent
weaknesses ofthe old rules, developed some interesting insights. By advancing the art
ofRSI analysis, his work enables us to use the Relative Strength Index to:
1. Establish trend in a given time frame
2. Anticipate trend reversals
3. Detect buy and sell signals
4. Calculate price targets
5. Calculate risk-reward
6. Determine trade entry and exit points and stop-loss levels
7. Establish significant trend lines and support/resistance lines
Inthischapter, we will examine some ofthe items inthis list,while some will be reviewed
when the signals and their validity are redefined.
These insights take the interpretation of the RSI to a new level. What made the
difference? In my opinion, the major breakthrough was the discovery of specific buy
and sell signals in the RSI. The method for Price Target Calculation, associated with
these signals, is taken from the Fibonacci method. Also, Wilder's 70/30 rule was
redefined and a more realistic and useful way of looking at specific RSI levels was
introduced.
Let's take a closer look.
Significant RSI Ranges
It does not pay to look for a specific level where a market can definitely and absolutely
be called overbought or oversold. As we saw in our earlier discussion, it is possible for
the RSI in an uptrend to rise to a value of75 and retrace to 65, while prices keep going
up at the same time. This is how negative divergence forms. From 65, the RSI may
reverse up, rising back to 75, while prices rally to new highs.
In practice, it appears to be more relevant to look at the range where the RSI is
moving. Obviously, the RSI travels mainly in the area between 30 and 70 because ofits
mathematical constraints. However, in bull markets, positive market sentiment shifts
the RSI range upward by about 1 0 points, where the range rests between 40 and 80.
This allows an uptrend in a particular time frame to be defined by simply looking at the
value range where the RSI is moving.
29

Walter] . 8aeyens
Conversely, in downtrends, negative sentiment causes the RSI range to shift downward
about 1 0 points. This leaves an RSI value traveling between 20 and 60, which is
symptomatic ofa downtrend in a specific time frame.
While the figures for the uptrend and downtrend RSI ranges do not constitute make-or
break limits, these important guidelines can be formulated. For a given time frame, the
RSI moving within the range from (roughly) 40 to 80 is symptomatic ofan uptrend. The
RSI moving within the range from (roughly) 20 to 60 is symptomatic of a market
downtrend.
-'Weekly NYSE la32.99 +0.33+1.01%8-32.86A-33.150-32.51t-t-33.03Lo-32.50C-32.99V-5127200 .00
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Figure 1.5 Weekly GM
In this weekly chart ofGeneral Motors, prices drop from about $55 to $20 during 2005,
before rebounding in 2006. While the RSI value reaches well over 80 in January of
2004, it never exceeds the 60-level after the price drop begins in April 2004. Also note
that the 30-level in the RSI is broken. The RSI value reaches the 20-level in April and
December 2005. Obviously, this is not a case where it would have been a good idea to
have purchased General Motors when the RSI reached the 30-level.
30

RSl: Logic, Signals & Time Frame Correlation
rn
wooled "'" T,odeS''''''
Figure 1.6 Weekly IBM
This weekly chart shows the strong rally in IBM from 1 996 to 2000. It is characterized
by the RSI staying well within the 40 to 80 range, thus identifying a bullish market. The
violation ofthe 40-level in the RSI (Quarter 4 of 1 999) marks the end ofthe strong bull
market and the start of a consolidation phase, with the RSI unable to exceed the 70-
level in2000 and 200 1 .
A Special Kind of Divergence
We know that the shift in the value ofthe RSI is not directly proportional to the change
in the underlying price. As the RSI measures the relative rate-of-change of prices,
(when the rate of the price increase begins to lose steam in a rally lasting over 14
periods), the RSI value may actually start to decline, while prices are still going up at a
more moderate pace. It is possible, in an uptrend, to see RSI values decline for a while
in that particular time frame. In a downtrend, rising RSI values often appear.
If we combine this characteristic with the fact that the RSI tends to speed up when
approaching the middle ofthe RSI range in the half-pipe effect, it becomes clear that
some seeminglyvery unusual RSI chartconfigurations arepossible. These configurations
could include rising prices combined with rapidly declining RSI values, or falling prices
combinedwith rapidly rising RSI values. Thesearethepropertiesthatmake this indicator
interesting, and it is important to know how to interpret them.
31

Walter J. Baeyens
We have already noticed that when the RSI value hits the 80-level or higher, this does
not mean that the uptrend is over; conversely, a downtrend is not simply ending because
the RSI has reached the 20-level or lower.
So, how do prices manage to move higher after they have propelled the RSI to 80 or
9O?
In simple terms, we could describe this phenomenon by saying that the RSI takes a few
steps back when hitting its limit, while prices barely move before charging upward
again. Each time the RSI reverses up, prices rally to new highs. If the RSI fails to
attain new highs in this process, we are witnessing the formation of a negative Price/
RSI divergence.
After hitting its mathematical resistance in a downtrend, the RSI value may pop up to a
less extreme reading, before resuming its plunge with renewed vigor, taking prices to
new lows.
In some instances, the rapid changes in the RSI value are markedly out-of-proportion
with the change in price. These changes are the basis of Cardwell's buy and sell
signals.
This is the underlying logic: Ifyou notice RSI moves thatare obviously out-of-proportion
with the corresponding price moves, expect prices to resume their trend with a vengeance
when the RSI reverses. This provides the basis for an important guideline: In an out-of
proportion RSI move, you are almost always on the wrong side of the market if you
follow the RSI. In an uptrend, ifthe RSI falls dramatically while prices hardly move
downward, do not be fooled into taking a short position; when the RSI bounces back,
prices will likely move to new highs.
In a downtrend, when witnessing an RSI jump, while prices hardly move, do not be
fooled into a long position. Once the RSI reverses back down, prices will likely fall to
new lower lows.
32

ReX - 1 5 min NASDAQ l-SO.98 -1 .62 -3.08% B-5O.99 A.-51.59 0-52.19 H-S2.89 Lo-SO.55 C-S1 .S9 Y-4736OO1
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Created wilh Tr"oostation
Figure 1.7 LRCX ( I 5-minute)
This chart illustrates the "peculiar divergences" between price and the RSI. Note the
differences in variation in price versus the RSI. The price drop from Level A to Level
B corresponds to a modest decline in the RSI fromA' to B', Point B' in the RSI is near
the 20-level, where the RSI is being compressed, In contrast, the minor price rebound
from Level B to Level C propels the RSI to Level C', The RSI move is markedly out
of-proportion with the rise in price,
The same thing happens from Points F' to G', where the RSI has a significant jump
after a minor price rebound (compared to D to E) from Level F to G. These out-of
proportion RSI moves, which I will relabel Disproportional Displacements (DD), form
the basis ofthe buy and sell signals in the RSI.
33

Walter J. Baeyens
X . 1 5 "*" No*SOAQ L..
50.9EI .1 62 ·3.D6'lo 6-50.99 ....
51.59 0.52.19 t+-52.89 Lo-5O.55 C-S1.59 V....7J6Q01
Figure 1 .8 LRCX ( I 5-minute)
11'13 19:45 1M. 18:15
20.00
10.00
This chart illustrates the Disproportional Displacements (DD) inthe RSI in bullish territory.
PART VI
THE CARDWELLIAN SIGNALS
The RSI Range-Shift
To quickly determine the trend in a particular time frame, look at the RSI chart and
check the range in which the RSI is moving. If the RSI is seen meandering roughly in
the range from 40 to 80, the trend must be up. The range from 20 to 60 is typical for a
downtrend. Consequently, we can expect to see a "range-shift" whenever the trend
changes in the examined time frame. Although a range-shift is likely to remain undetected
until after the fact, it is still a useful signal.
A range-shift down occurs whenever the RSI fails to rise above 60 in a rally after an
unusually large price drop. Imagine the RSI moving in bullish territory, while prices are
steadily rising. At a certain point, a price correction down takes the RSI lower to the
25-level (in bear territory). If the rally in the market is to continue, the subsequent
rebound in price should see the corresponding RSI value exceed the 6O-level, back into
bullish territory. Ifthe RSI fails tobreakabovethe 60- to 65-level andreverses downward
from there, the price correction may have signaled the start of a trend reversal.
34

We can now conclude that we should use two interesting RSI levels as main references
to determine the market's mood: The RSI values of 40 and 60. In the smaller time
frames, RSI range-shifts will be observed more often than in the larger time frames,
simply because the average day-to-day moves in the market are large enough to send
the RSI whipsawing up and down near its extremes. Still, a market that is unable to
push the RSI value above the 60- to 65-level in a small time frame (e.g. 1 0 minutes) is
signaling extreme weakness.
In a very strong market, price corrections to the downside may be so shallow that they
do not even cause the RSI to dip below 40 in the smaller time frames.
Figure 1 .9 shows a range-shift using the skaters' halfpipe concept. Ifwe return to the
idea that an RSI chart is similar to a skaters' half-pipe, we can imagine this half-pipe
balancing on a pivot point, with the bulls on one side and the bears on the other. At the
side corresponding with the 1 00-level in the RSI, the bulls are trying to tilt the balance
their way. Ifthey succeed, the market turns bullish and the half-pipe is tilted in such a
way that a skater (the RSI) will have no problem reaching higher-than-usual RSI levels
near the 100-edge. To do this, a swing-back to the 40-line on the opposite side will
suffice to build up the required momentum. Conversely, in a bearish market, we can
imagine the half-pipe being tilted the other way with the skater (the RSI) going back
and forth between the near-zero level and the 60-level.
An RSI range-shift could be visualized by imagining the half-pipe tilting eitherway as
time passes, forcing the skater out ofthe bear part ofthe half-pipe, then into the bull
part andback.
.X(O) -DeIIy CBOfl-595.45+7.96 +1.36% 8-594.94 A-59S.S4 0-se7.47 HI-S99.83 L0-587.47 C-595.45 V-O
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Figure 1 .9 Daily Oil Index
3S
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Walter 1. Baeyens
This daily chart ofthe OIL INDEX offers a good example ofRSI range-shifts. In May
2002, the RSI is unable to exceed the 60- to 65-level before the price drop. During the
subsequent bear phase of the market, the RSI is unable to exceed the 6O-level, while
dropping as low as 20 in July 2002. In 2003, the RSI drifts upward and is finally able to
break above the 60-level in mid-2003. The RSI drop following this range-shift in June
and July of2003 is markedly out-of-proportion with the corresponding decline in prices,
but still remains within bull territory. This illustrates the rule that you should not be short
when the drop in the RSI is out-of-proportion with the decline in price.
Figure 1 .1 0
80
BEARS
Figure 1.10 The RSI Half-Pipe
Buy and Sell Signals
We have already briefly discussed the emergence of peculiar divergences in the RSI,
where the fluctuations in the RSI are markedly out-of-proportion with the corresponding
moves in price. A buy signal is formed whenever this type ofRSI behavior results in the
following situation: The RSI reverses up from a lower low, while price rebounds from
a higher low. In other words, a shallow correction down in price to a higher low has
caused an out-of-proportion drop in the RSI to a lower low. As the RSI reverses back
up, we may expect prices to resume their rise, reaching new highs.
A sell signal is formed when a shallow price retracement up to a lower high causes the
RSI to move up in a disproportional way to a new high. As the RSI reverses down, we
may expect prices to resume their decline with a vengeance, reaching new lows.
This may sound complicated. However, in practice, these particular divergences are
easy to find, once you know they exist and what they look like.

Andrew Cardwell called these signals positive and negative reversals. It was his
view that the emergence of a positive reversal in a downtrend meant the trend was
changing to an uptrend. In an uptrend, the emergence of a negative reversal marked
the point where the trend changed to a downtrend.
In my opinion, the designation positive or negative "reversal" is not appropriate, as the
subject signal often merely confirms the continuation ofan existing trend. Only when
these signals appear for the first time, could they be seen as "reversal" signals. These
signals were added to his Trend Determination Checklist, as he claimed that positive
reversals or buy signals will only show in an uptrend, while negative reversals or sell
signals only show up in a downtrend. Ifa market is in a downtrend and suddenly a buy
signal is detected, it could be concluded that the trend had changed to an uptrend. In
this case, the use ofthe term "reversal" isjustified, but in a strong trend, a sequence of
signals ofthis type can be found, each one confirming the strength ofthe existing trend.
We must specify the time frame from which these signals are supposed to be taken. I
would like to add that these signals are indicative ofthe trend in the time frame where
they are detected.
TheTrendDetermination Checklist, including the RSI buy and sell signals, suggests that
there is an easy way of determining the existing trend in an absolute way. In reality,
applying the checklist to different time frames leads to different conclusions. Trend is
obviously time frame dependent. For instance, it is important to point out that signals
taken from the hourly RSI should not be used for long-term trend determination. In
other words, when discussing the actual trend, always clarifythe referenced time frame.
It is not unusual to detect a buy signal in the daily time frame, while a sell signal shows
up in the hourly time frame.
37

Walter 1. Baeyens
TC .Weekty N.&.SOAQ l-21.S4 +015 +{)70% 8-21.63 A..21 .67 0-21.40 tt-21.8S Lo-21 ..38 C..21 .60 V..789S24SO
J
111.1
999 A
Figure 1.11 Weekly INTEL
o
DealedWIth TIadeSlallon
This weekly chart of INTEL offers some relevant examples ofbuy and sell signals in
the RSI:
Points A'- B'
The RSI is lower at Point B' than it was at Point A', while the corresponding price at
Point B is higher than at Point A. This "peculiar divergence" is a buy signal. Also note
that the RSI signal occurred in bullish territory, well above the 40-level. The buy signal
could be called a "reversal" signal because it is the first buy signal in this time frame
leading to a rally.
There are other buy signals at Points C'-D', D'-E' and F'-G'. These are valid buy
signals that confirm the strength ofthe ongoing rally.
Points X'-y'
The RSI is higher at Point Y' than it is at Point X', while Price Y is lower than Price X.
This is a "strong" sell signal because the signal is formed within a very tight M-shaped
pattern. A second sell signal is defined at Points Y' and Z'. Past Point Z', a positive
Price/RSI divergence leads to the end ofthe decline.
RSI Moving Averages
Cardwell pointed out that it is useful to add moving averages to the RSI chart. In
particular, the moving average crossovers mark significant points in the RSI chart. The
recommended settings for these moving averages are the 9-period simple moving average
and the 4S-period exponential moving average. Additionally, it has been suggested that
38

the same moving averages be applied to price, which may allow a correlation between
both charts.
When a buy signal is witnessed, conservative traders are advised to wait until the
crossing up ofthe moving averages in price confirms the RSI signal in that particular
time frame. A sell signal in the RSI should be confirmed by the moving averages in price
crossing down.
In my opinion, this degrades the relevance of this type ofRSI signal. The crossing of
the moving averages in price is a signal, and one couldjust as well state that whenever
these moving averages cross, the existence ofa buy or sell signal in the RSI confirms
the price signal. In other words, an RSI sell signal could be disregarded as long as the
9-period simple moving average remains abovethe4S-period exponential movingaverage
in price, as it is indicative ofa bull market. An RSI buy signal could to be disregarded as
long as the 9-period simple moving average remains below the 4S-period exponential
moving average, as it is indicative ofa bear market.
Most analysts, traders and investors keep an eye on price moving averages because
they allow the state of the market to be assessed quickly. The question is: which
moving averages are significant in which time frame? Short-term traders may look for
signals in the S-period simple moving average and 20-period simple moving average in
the hourly price charts, while conservative long-term investors may be interested in the
SO-period simple moving average and 200-period simple moving average in the daily or
even weekly price charts. Perhaps Cardwell's rationale for selecting these particular
moving average settings was due to the fact that they are on the conservative, long
term side of the spectrum.
In some of the RSI charts in this book, the 9-period simple moving average and 4S
period exponential moving average will be displayed. I find them useful to determine the
preferred RSI channel anchor point in cases where several such reference points appear
to be plausible.
39

Walter J. Baeyens
Figure 1.12 Weekly IBM
J J
120.00
110.00
35.00
25.00
00
Cremed with TredeStation
In this weekly IBM chart, moving averages have been added to the RSI. The arrow
marks the crossing down of the short-term and long-term moving average, which
coincides with the start ofa major price decline. Points X' and Y' define a sell signal.
Price Target Calculation
The Cardwell method for Price Target Calculation is similar to the one used in the
Fibonacci-logic. When price resumes its trend after a shallow retracement, we may
expect the extent ofthe next price move to be 80% to 1 00% ofthe previous move. In
an uptrend, if a price correction down is (logically) assumed to be shallow when it
causes a buy signal in the RSI, we can say that the price move following the RSI buy
signal will take prices to a new high. The price target can be calculated by adding the
extent of the previous price advance leading up to the retracement down to the price
level where the uptrend resumes.
40

C .''''eeld.,. NASDAQ L-21.64 -t<l.15 +0 70% Ba21.83 .11-21 .67 0-21 40 Hi.21.85 Lo-21.38 C-21.60 V.789S2450
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Figure 1.13 Weekly INTEL
.999 A o o
70.00
65.00
60.00
55.00
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ill
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Let's return to the weekly INTEL chart and take a closer look at the buy signal that was
formed between Points A and B in the RSI. The price target for this buy signal is
calculated as follows: Determine the change in price between Points A and B and add
this value to the price high in between the signal reference points.
The difference in price between A and B is 26.5 - 2 1 = 5.5.
The price target for this buy signal is 35.2 + 5.5 = 40.7
41

Walter 1. Baeyens
.WeeIdy NVSf L-32.99 +0.33 +1.01% 6-32.86 A-33.15 0.32.51 ....33.03 Lo-32.50 C-32.99 V-S127200
55.00
50.00
.5.00
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30.00
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20.00
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00.00
70.00
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30.00
20.00
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A A
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Created with TradeStabon
Figure 1 . 14 Weekly General Motors
This weekly chart of GM was used earlier to illustrate the 20 to 60 RSI range in bear
markets. There is a sell signal at Points X' and Y'. The price target for this sell signal
is calculated by taking the difference in price between Points X' and Y' and subtracting
this value from the low price between the signal reference points.
The price difference is 43 - 36.8 = 6.2.
The price target is 25.6 - 6.2 = 1 9.4.
RSI Signal Strength
Which RSI signals will prove to be valuable? What characterizes "strong" RSI signals
(those which offer the best chance ofreaching the price target)?
One opinion supported by Andrew Cardwell is that the fewer periods separating the
RSI signal reference points, the stronger the signal, with a higher probability that price
will reach the calculated target. Using this logic, a 3-period RSI signal with only one
period between reference points should be considered the strongest possible signal.
This rule holds up; it implies that the price retracement must have been extremely
shallow. But then again, a 3-period signal in the daily RSI chart could correspond to a
1 3-period signal in the hourly RSI chart.
I remain skeptical about this statement regarding the strength ofRSI signals as it
implies that modest price targets barely exceeding the referenced high or low are
more likely to be reached, which is not surprising. In my view it is more important to
42

check whether or not there were adverse RSI signals present in the smaller and
larger time frames.
Cardwell's Target Price Calculation method starts from the assumption that the price
move following a shallow retracement will correspondto 1 00% ofthe price move prior
to the retracement. John Hayden links the probability ofan ascertained price target to
the percentage of retracement that caused the signal. This Fibonacci-related method
results in a matrix of probabilities, ranging from "will easily exceed price target" in
cases where the retracement is less than 23.7% to "probably will not exceed 80% of
calculated price change" in cases where the retracement is over 76.3%.
Studying Cardwell is certainly valuable, as it is an alternative to the Wilder-style rules
with some practical interpretationguidelinesanduseful signals. However, some questions
remain. In particular, the interpretation ofpositive and negative Price/RSI divergence
is left unanswered. Hayden believes that simple divergences are just temporary
deviations from the main trend. In this respect, he confirms Cardwell's view that
negative divergence is merely symptomatic ofan uptrend and positive divergences are
symptomatic ofa downtrend.
According to Hayden, trend changes are preceded by multiple, long-term divergences
(as opposed to simple divergences). Unfortunately, this description is far too vague to
be ofpractical use when studying RSI charts and a definition of"multiple divergences"
is not given. It is only logical that an RSI range-shift may be preceded or caused by
repeated, persistent divergences that eventually succeed in pushing the RSI over the
edge. Of course, we still have the RSI range-shift warning ofpotential trend changes.
Ifthe RSI shows signs that point to the half-pipe tilting the opposite way, the upcoming
move may be a major one.
Recap
Let us review:
There is no way to determine, in absolute terms, when a market is oversold or overbought.
In most cases, the occasional divergences between the RSI and price do not lead to
trend changes. Also, trends are time frame-specific.
Some interesting concepts were introduced by Andrew Cardwell. He discovered that
some peculiar Price/RSI divergence signals can be used as buy and sell signals. Such
a buy signal divergence occurs whenever a lower RSI reading corresponds to a higher
low in price or when a shallow price retracement down in a bull market causes a lower
low in the RSI. A sell signal occurs when a shallow price retracement up in a bear
market causes a higher high in the RSI.
Price trend is reflected in the RSI in particular time frames in its range oftravel. In bull
markets, RSI values will range from (roughly) 40 to 80, while in bear markets, the RSI
range is from (roughly) 20 to 60. A trend change in price will be reflected in the RSI by
a range-shift.
43

Cardwell also proposed a method to calculate the projected price targets for these buy
and sell signals. This method is taken from the Fibonacci analysis method, which says
that after a shallow price retracement, the next price move with the trend will be (nearly)
equal to the one leading up to the retracement. Cardwell's preferred RSI buy and sell
signals are those with reference points that are very close, sometimes separated by a
single price bar. These were called "strong" signals, as he apparently found that these
often propelled prices to their projected targets.
Unfortunately, the reference time frame is not so specific that one can take these RSI
signals from it. Wilder supposedly made reference to the daily RSI; Cardwell seems to
indicate that his method is best suited for the weekly time frame.
Both interpretations lackthe depth ofTime Frame Correlation. At any one point in time,
the price reality can be described by a large number ofvalid RSI pictures. There is not
just one RSI chart that correctly describes a specific price action because each time
frame produces a different RSI picture. There are many RSI pictures describing one
reality. Each picture tells a different (but true) story, so why restrict the RSI analysis to
just one time frame?
In the methods we have discussed, some questions remain unanswered, but will be
addressed in the forthcoming chapters. How does one interpret RSI signals in the
smaller time frames? When do RSI signals become invalid? When exactly is a signal
considered to have failed? What ifwe find contradicting RSI signals in aparticulartime
frame? Also, what is the nature ofPriceIRSI divergences and what is their significance?
What is the significance ofthe signals' price targets?

CHAPTER Two
THE SLANTED RSI UNIVERSE

PART I
THE RSI DISTORTION
In this section, I will demonstrate that thebest way to study RSI charts is to use slanted
reference lines rather than horizontal reference lines as we would in price charts. This
means that when prices rally in a staircase-like advance, the resulting RSI chart will be
in the formation of a series of-slanted segments or channels. In a price decline, we
will find I-slanted channels in the RSI. Understanding this RSI logic is essential for
further analysis.
When analyzing RSI charts, one ofthe first problems encountered by the user is that
the RSI chart looks so much different than the price chart. Look at a bull market, for
instance. Prices on the chart rise steadily, while the RSI values on the chart meander
up and down in a nearly horizontal range, roughly between 40 and 80 in RSI bull
territory.
Figure 2.1
80,
,
"
"
"
c
60
,
"
120
1 1 5
1 10
100
Let's try to make the RSI chart resemble the bull market price action more closely. If
the RSI charts are printed on paper, then cut and pasted in a strip, this strip could be
overlaid in such a way that it mimics the price movement in a climbing range. This
results in something that looks like Figure 2. 1 , which is an RSI staircase going up in
steps similar to the underlying price moves while the RSI values are still confinedto the
range between 40 and 80.
In a bear market, the RSI chart cascades down and oscillates roughly between the
values of20 and 60 in the RSI bear range. In Figure 2. 1 , the RSI strip has been tilted to

Walter 1. Baeyens
align with the price uptrend. The corresponding rising prices are symbolized by the
horizontal lines in the right comer ofthe chart and are labeled 1 00 to 1 20.
Points ofequal price, (e.g. Price 1 20), in the RSI define a declining Line A-B, where
Point B is at a lower RSI level than Point A.
At Points C and D, the situation is more extreme: Point D is at an RSI level of45 that
corresponds to a price level (that is not equal to, but higher than) Point C, which is at an
RSI level of60. This immediately brings us to an important point. In bull markets, this
specific type ofPrice/RSI correlation appears where a higher price low is reflected in
the RSI by a lower low. This corresponds to the RSI buy signal introduced by Andrew
Cardwell. It is formed when the RSI rebounds offofa lower low, while the corresponding
price reverses up after a mild correction down.
When this appears in the RSI chart, it indicates that the market is a bull market in that
time frame. In a bear market, the horizontal line in the price chart connecting points of
equal price corresponds to a rising line in the RSI chart. Let me repeat that I see no
reason to call these "reversal" signals, as their occurrence in most instances only confirms
the strength ofthe trend in force.
A down-up sequence in price trend results in a down-up sequence ofthe RSI strips, as
depicted in Figure 2.2. In the bullishpart ofthis chart, Line a-b connects points ofequal
price; in the bearish part, Line x-y connects points ofequal price.
Figure 2.2
RSI RANGE-SHIFT : UP -+ DOWN
48

Figure 2.3
80
Ifan up-down trend change is represented in one horizontal RSI strip, as ifpresented
on a PC screen, the chart looks like Figure 2.3. This is what an RSI range-shift looks
like, possibly preceded by what could be a negative divergence, pushing the RSI below
the40-1evel.
49

Walter 1. Baeyens
11(28 18:.5 11129 16:45 1100 18:45 1W1 18:45 12.04 18:45
iii
Figure 2.4 LRCX ( I S-minute)
This chart was used earlier to illustrate the "peculiar divergences" that exist between
price and the RSI. In this example, the RSI hits resistance at Point Y'. If this drop in
the RSI is compared to the drop in price from Point X to Y, we can see the effect of
their logarithmic correlation.
The modest price rebound from Point Y to Z causes a spectacularjump in the RSI from
Point Y' to Z'. This RSI distortion ofprice reality leads to the following conclusion: In
a bear market, points of equal price (Line W - Z) will define a rising reference line
(Line W'- Z') in the RSI. So, if we study price changes in relation to their horizontal
references or price levels, we must then study the corresponding RSI changes in reference
to their slanted reference lines.
50

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Figure 2.5 LRCX ( I 5-minute)
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In bull markets, due to RSI distortion, the line that should be used as a reference to
study changes in the RSI versus changes in price (Line D-E), is a declining line (Line
D'-E').
PART II
RSI ZOOM-IN
Anotherparticularityofthe Relative Strength Index is that its picture changes significantly
when switching from one time frame to another. Price levels remain unchanged whether
they are examined in a daily time frame or in a 1 5-minute chart. This is not the case in
the RSL The outcome ofthe RSI calculation in the hourly time frame, typically covering
14 hours ofdata is totally different from the RSI picture in the daily chart covering data
ofthe last 14 trading days.
This time frame specific behavior makes the RSI study interesting because it allows us
to analyze and correlate various RSI pictures describing one price action within a
given time period. This is like looking at a particular price behavior from various angles,
which can be correlated because they describe different aspects of the same reality.
51

Walter J. Baeyens
Figure 2.6 PRICE·RSI I TIMEFRAME RELATIONSHIP
I WEEKLY PRICE
I WEEKLY RSI
.. .... ... ..... .. .. ..... .. ... .. ....... ... .. .. ..... .. ... .. ... .. ... . _ m . ... ...... . .... ... ....... ..... .... ....�.............
I DAILY RSI
. ...... . . ................... . . ....... . . ....... . . ........ . .......... . . . . . . {��
52

Let's take a look at Figure 2.6. The chart shows a long-term bull market in the weekly
chart. The course of the weekly RSI (more or less) resembles the course ofthe price
action in that it is heading up for most ofthe time, meandering within bull territory.
Looking at the same price action up for the same period of time, but examining the
corresponding RSI chart in the daily time frame, we notice that the general aspect of
the chart does not directly reflect the uptrend. The RSI values oscillate up and down,
roughly between the 40- and 80-level. This fact indirectly tells us that the trend must be
up.
Zooming in even further on the hourly chart, we see that there are more frequent and
wider oscillations in the RSI that often alternate between bull and bear territories. The
reason for this behavior is that relatively shallow price retracements accompanying a
bull market ofthis magnitude are sufficient to push the hourly RSI values into its bear
range for a period of time. Strong moves upward may lift the RSI above its normal
values, occasionally reaching a value of 85 or more. This is often the case after a
shallow price correction down, when prices rally strongly. In the RSI calculation period
of 14 hours, momentum turning from mildly negative to strongly positive results in the
largest momentumjumps, relatively speaking.
In the hourly RSI chart, the uptrend will be indirectly visible because the RSI spends
more time in the range between 40 and 90 than it does in the 60- to 10-zone. Additionally,
within the 40- to 90-range, a series ofbuy signals provide further indirect evidence of
the uptrend. There might be the occasional sell signal, caused by price declines that
lead to the formation ofbuy signals in the daily time frame. These price declines that
are shallow in the daily picture, may turn out to be deep enough to cause sell signals in
the hourly time frame. From this series of comparative charts, the need to correlate
different RSI time frames in order to assess the market conditions and anticipate high
probability scenarios becomes clear.
My preferred set oftime frames for RSI analysis is the weekly-daily-hourly combination.
For shorter-term trades, I prefer to use the daily-hourly-1 5-minute combination.
PART III
RSI SEGMENTS AND CHANNELS
In a bull market, rising prices find their expression in the RSI chart in the up-down
cycles in bull territory. This is characterized by the peculiarity oflower lows in the RSI
value corresponding to higher lows in price. In a bear market, the RSI up-down cycles
in bear territory are characterized by higher highs in the RSI corresponding to lower
highs in price. These features were used by Andrew Cardwell to define his buy and sell
signals.

Walter 1. Baeyens
Remember that these signals can be used to determine trend direction and in some
cases point to possible trend reversals. We also find the need to use slanted reference
lines in the RSI chart when studying price change. This leads us to study the RSI price
relationship by examining RSI behavior in relation to these slanted reference lines. It
makes sense to anchor these reference lines on RSI extremities with some significance.
For example, we could use the buy or sell signal reference points. Let's see where this
idea leads us. Figure 2.7 shows the I S-minute LRCX chart that was studied earlier
when discussing the peculiarPricelRSI divergencethatproduces thebuyandsell signals.
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In this chart, we find that there is a buy signal at Points A'- C'. If Line A'- C' is used as
a reference, other significant parallel lines can be defined as well.
For instance, Line B'-F'-G' runs parallel to Line A'- C', starting from the RSI top at
Point B'. There is another buy signal at Points F'-G'. In fact, a buy signal is formed
when the RSI bounces offthe top reference line ofthe previous RSI slice or segment.
This is what happened at Points A'- C' as well. We end up with three RSI segments in
this chart.
There is one segment below the Line A'- C'; there is another RSI segment defined by
the lines A'- C' at the bottom and B'-G' at the top; and finally there is the one building
above the Line F'- G'. These RSI segments correspond to the different steps of the
price staircase. The arrows indicate where the RSI jumps from one segment into the
next higher one. Each time this happens, prices rally with renewed vigor. Let's call
these RSI segments "channels." Later, we will see that these channels are being
formed within a larger ChanneF.
54

It should be noted that large Channels2 may correspond to "normal" channels in the
larger time frames.
Descending channels are typical for bull markets; ascending channels are relevant in
bear markets. In practice, we will look for significant descending or ascending channels
whenever they can be anchored to RSI signal reference points and clearly correspond
to the consecutive phases in the underlying price behavior. Important lessons about
probable future price moves can be learned by watching the RSI move within or break
out ofestablished channels.
Traders who know the Elliott Wave theory will be familiar with the concept of the
"Russian Dolls" aspect ofthis analysis method. As you zoom in on an impulsive wave,
studyingparts ofit in smaller time frames, you will f
md ever smaller identical impulsive
waves as subdivisions within the original, larger impulsive wave.
The same goes for the various RSI channels. What is labeled a "ChanneF" in one time
frame could very well correspond to a channel in a larger time frame. In this respect,
these channels provide a link between various time frames and can be used as a tool for
the correlation ofthe RSI pictures. Most relevant will be the study ofRSI value moving
within the channels, ofthe break-outs from these channels, and ofthe effect this has on
its ChanneF or on its channels in the larger time frame.
FIGURE 2·8
- - - - .. _
-
..... _
- - - - - - -
CHANNEL3
Channel2
- - - - - - - -
Channel
o
... - - ... - - - - -.
Figure 2.8 illustrates how channels of various sizes appear in the RSI chart of an
uptrend. The initial primary RSI channel leads up to Point X, where the RSIjumps into
the next RSI segment, or channel. Suppose a buy signal is formed at Points A- B, so
Line A - B - D can be used as the lowerboundary ofa descending primary channel. As
the RSI reverses up at Point D, at around the 40-level, we could imagine that there is
55

Walter J. Baeyens
another buy signal that defines the lower boundary of ChanneF. At Point C, the RSI
jumps into the next RSI channel.
In short, we have primary up-down RSI channels within a descending ChanneF, anchored
on (DD+) reference points. All ofthis could be situated within an even larger ascending
ChanneP. All channels, no matter their size, have RSI signal reference points on their
lower or upper boundaries. To find these larger signals, we switch to a larger time
frame, where the ChanneP and its reference points will be clearly visible.
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Figure 2.9 Weekly Dow Utility Index
This chart illustratesthe channels-within-channels concept. The descending RSI channel
is the down leg within the larger descending ChanneF. This ChanneF is a down-leg
within the ascending ChanneP. Note that the RSI low in April of2006 is near the 40-
level in bull territory.
56

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This is a close-up picture ofthe weekly chart where a negative divergence defines the
upper boundary ofthe descending ChanneF. Note that the low price inApril 2006 does
not correspond to a lower low in the RSI as it did in the weekly chart. The dashed line
in the RSI defines the lower boundary of a potential new ascending channel. In the
weekly chart, this would mean that the recent RSI rise from the bottom ofits ChanneP
is the start ofan up-leg within ChanneP.
PART IV
RSI CHANNEL LOGIC
We have analyzed how the RSI formula distorts the underlying price picture and
transforms it in a segmented RSI strip. These RSI segments, or channels, have properties
depending on whether they are a product ofbullish or bearish conditions. Consequently
it makes sense to analyze the RSI by checking which channels are meaningful.
Up-trending markets are characterized by descending channels where buy signals will
form, indicating that the rally is continuing. In fact, we will look for RSI channels that
are anchored on the buy signal reference points. Downtrends are characterized by
ascending channels, where sell signals will form. The significant channels are those
57

Walter 1. Baeyens
anchored on the sell signal reference points in the RSI. When an RSI buy signal
appears in a downtrend or an RSI sell signal appears in an uptrend, these may be early
indications ofa trend reversal in that time frame.
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Figure 2.1 1 Daily BG
Let's analyze the BG daily chart. Ourfirst task is to find some relevant segments in the
RSI. Lines A, B and C connect some tops and troughs in the RSI chart. Are these lines
significant? Line A connects higher highs in the RSI, but these correspond to higher
highs in price, so there are no sell signals defined on LineA. Line B connects some RSI
lows at the left ofthe chart, then, to the right ofthe center ofthe chart, Line B connects
some RSI tops, but again, the RSI tops correspond to higher highs in price, so there are
no sell signals here either.
No wonder there are no sell signals here. The price trend is clearly up in the right half
ofthe chart! Line C seems to have some significance as it connects some RSI extremes,
but no buy signals are found on Line C.
But wait a minute. If prices are in an uptrend, we should be looking for descending
channels (where there should be some buy signals).
58

RSf: Logic, Signals & Time Frame Correlation
Doiy NYSE l.S9.58 -0.04 -0.07'1. 8-59.58 A'().OO 0-59.77 11-59.89 lo-59.38 C-59.B7 Y·435900
Figure 2.12
This is much better! The descending channels make much more sense. They had been
staring us in the face all the time. The segments in the RSI correspond to the consecutive
phases in the price rally. The switch occurs when the RSI breaks out from one segment
andjumps into the next. Where are the buy signals? Actually, several were detected in
this chart.
Line A connects lower lows in the RSI that correspond to marginally higher lows in
price, so line A defines a modest buy signal. Lines B and C define the bottom ofthe
second RSI segment. Here, we also have a buy signal. From the Line B - C, the RSI
risesandpops into the third segment.
Lines D and E define buy signals. Please note that the RSI in this channel does not rise
above the 60- to 65-level. As we have learned, this indicates market weakness.
At Point F,the RSI breaks outonce more in a FASTbuy signal withthe RSI well within
bull territory. The price advance becomes steeper in this sectionand consecutive shallow
retracements in price cause buy signals in the RSI.
Let's move from this discussion and define the 2nd degree channel in this chart as
shown in Figure 2. 13. When the extremities ofthe RSI channels are connected in the
previous chart, a ChanneF, which can be used for further reference, is obtained.
59

Walter 1. Baeyens
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2.13 Daily BG
The upper boundary ofChanneF reaches the 95-level at the extreme right side of the
chart. Does this mean that the RSI could keep going up to that level? It is certainly
possible to see the RSI reach the 90-level, as it did in January 2004, but that is not
required for prices to continue their advance.
In November and December of2004, the RSI struggles at the 80-level. Each time the
RSI reverses up after a setback, prices reach new highs. So, we could see the
developmentofa negative divergence with prices flat or still rising moderately while the
RSI drops to more reasonable levels, possibly to the lower boundary of its Channel2,
where another buy signal could form.
There is a similar scenario between January and May of2004, from Line B - C. After
the RSI hits the 90-level, a negative divergence pushes it down toward the lowerboundary
ofChanneF, while prices keep rising. The price decline that follows in April of2004, as
the RSI is finally pushed below 60, results in a shallow retracement. The reversal up of
the RSI in May 2004 triggers the buy signal. Also note the steeply out-of-proportion
drop in the RSI in February of2004, which leads to the formation ofa subsequent buy
signal.
Let's discuss how the end ofthe rally will become visible in the RSI chart. Imagine the
RSI meandering in one of its consecutive bullish segments, like the ones we have just
60

discussed. However, this time the RSI does not break out into the next up segment, but
rather remains within its descending channel.
As the RSI value drops lower within its descending channel, itwill reach bearish territory
at some point in time; no more buy signals can be detected on the lower boundary ofthe
channel. If the RSI remains unable to break out, sell signals will appear within the
descending RSI channel. In such a case, this initial sell signal could be called a "negative
reversal," as it suggests the end of a series of buy signals and may lead to a trend
change.
In this trend-reversal process, it takes quite some time before the first sell signal is
detected in the daily RSI chart. After all, a sell signal forms after a shallow price
retracement up within a price decline. In the daily time frame, such a price decline can
be quite substantial, meaning that some serious losses could be suffered before the sell
signal materializes.
In order to limit the time and the price swings required to produce a sell signal, switch
the analysis to the hourly time frame. There will be other signs in the RSI warning us of
potential trouble. In the case we havejust discussed, the first warning is the RSI-drop
below its ChanneF.
Figure 2. 14 shows a potential scenario for the BG Chart previously discussed. We left
the BG Chartwiththe RSI moving within its ascending ChanneF, which corresponds to
the channel at the top left ofthe hypothetical RSI chart.
At Points A - B, there is one more buy signal within the ChanneF. At Point A 1 , the RSI
fails to break out and jump into the next-up RSI segment. Prices reach a new high
because we are around the 80-level in the RSI chart. At that level, each reversal up in
the RSI takes price to a new high. As a result, there is negative divergence at Point A I .
At Point X, the RSI value drops below ChanneF, but is still well within bullish territory.
As the RSI reverses up from Line 1 , it produces a buy signal and the RSI rebound to
Point Y takes price to a new high again. In other words, the negative divergence
persists. After this buy signal, if the RSI manages to stay within its new ascending
channel or above Line 1 , the RSI will be rising to new highs in bull territory and it will put
an end to the negative divergence. However, the RSI does not rebound off Line 1 ; it
breaks below it.
No problem, the RSI is still in bullish territory (although getting closer to the bearish
zone) and the reversal up from Line 2 produces yet another buy signal. This time the
RSI rise, following this buy signal, results in a lower high in price. The rally is weakening.
By now the RSI is caught in a descending channel. This is typical for an uptrend as long
as buy signals form at the lower boundary. So far, this has been the case. At this point,
ifthe RSI manages to stay above Line 2, a new ascending channel will develop, parallel
to the initial channel, but at a lower RSI level.
61

Walter 1. Baeyens
Figure 2.14
Channel2
CHANNEL3
-
-
-
-
--
-- --
The RSI fails to stay above Line 2 and fails to break the negative divergence. As the
RSI breaks below Line 2, it drops to Line 3. However, the reversal up does not produce
a buy signal. When dropping to Line 3, the RSI enters bearish territory, breaking well
below the 40-level. This means that small moves down in the RSI correspond to larger
price drops.
The rise in the RSI, following the rebound offofLine 3, ends with a reversal down after
reaching Line 2, this time forming a sell signal in the process (reversal signal), while
failing to breakout ofthe descending channel once again. The RSI breaks below Line
3 at a value well below 40 and the price decline accelerates. Each time the RSI turns
lower, prices get hurt. In a final decline, the RSI reaches the 20-1eveljust shy ofLine 4,
as prices continue their drop. At last the RSI hits its mathematical resistance and starts
to curl up past Point C.
This does not mean that the price decline is over. It is the start ofa positive divergence
into Point E. In this zone ofthe RSI chart, each rise in the RSI means little change in
price, while each reversal down in the RSI causes prices to move lower quickly. Past
Point E, the positive divergence persists as the RSI stays above Line 4 and the RSI
finally escapes from its descending channel.
Again, this does not mean that price resumes its uptrend, as we have yet to see any buy
signals. Past Point E, the RSI pops up and reverses down from Point F, forming a sell
signal. Following this sell signal, ifthe RSI should drop below Line 4, prices would get
hit hard again.
62

However, the RSI stays within its new ascending channel defined by sell signals at its
upper boundary. This will eventually lead the RSI to values above 40 again while the
price decline bottoms out.
If the RSI manages to stay within its newly formed ascending channel past Point G, a
first buy signal (reversal signal) will form within this channel as it advances into bullish
territory. This means that we have returned to the uptrend andany up-move in the RSI
will correspond to a real price advance, while declines in the RSI will no longer depress
pnce.
The whole of this cycle could be placed in an imaginary descending ChanneP. This
channel is probably visible in the larger time frame (e.g. weekly chart) and we could
ask ourselves if the RSI rebound from the low around Point C is really a buy signal.
(There is no way we can tell from this chart, as it does not display corresponding
prices).
Let's assume that there is no buy signal at the lower boundary ofChanneP. What does
thatmean? It meansthatwe may see the formation ofa large sell signal within ChanneP,
unless the RSI, or the "new ascending RSI Channel2," succeeds in breaking out from its
ChanneP.
Disproportional Displacement: (DD+) and (DD-)
We have learned to look for significant channels in the RSI chart. RSI channels are
"significant" when they define buy or sell signals. In up-trending markets, we should be
able to find descending channels anchored on buy signal reference points. In down
trending markets, we should be able to detect ascending channels anchored on sell
signal reference points. These buy and sell signals are (basically) those defined by
Andrew Cardwell. As we advance from this basis, I will start using new symbols for
the buy and sell signals.
As the underlying phenomena for these signals are out-of-proportion moves in the RSI
versus price, I will label these signals Disproportional Displacements or (DD). The
bullish type (DD) signal will be labeled (DD+), while the bearish type will be labeled
(DD-). This should also clarify any confusion about the meaning of"sell signal," as this
type ofsignal should not always trigger the "sale" ofanything. A "buy signal" should
not automatically lead to the conclusion that it is advisable to enter a long position. It
might also mean that is a good idea to reduce a short position.
The use ofthe acronyms (DD+) and (DD-) resolves this type ofconfusion, especially
as several conflicting (DD) signals of either type may be encountered in the RSI,
especially when studying various time frames. The final result of the RSI analysis:
These various (DD) signals will determine whether it is advisable to enter orexit either
a long or short position or to stay flat.
We are preparing to re-examine these signals in relation to the channels they define.
This will result in somenew insights regarding the RSI and we will be able to discover
some important things about the validity ofthese signals.
63

Walter 1. Baeyens
Figure 2.15 HEAD & SHOULDERS
Figure 2.15 Head & Shoulders Formation
This is another example ofwhat RSI channels look like and how they correspond to a
price action. The price chart displays a Head & Shoulders (H&S) formation. An H&S
is a typical (potential) reversal pattern in price. After a series ofhigher highs, prices do
not manage to rise above the last top and consequently form a first lower high (right
shoulder).
When a lower high is formed, it could be the start ofa decline or trend change. However,
the decline just prior to the right shoulder must have been shallow, so normally we
should see a resumption ofthe rally. The make-or-break limit is the neckline. When
prices break below the neckline, a continuation ofthe price decline is to be expected. In
the context ofElliott Wave, we could imagine that the head is the top offinal Wave 5,
followed by a textbook correction down to the area ofthe previous Wave 4. The head
and the right shoulder could be labeled "cup and handle," or "negative wedge."
Now, let's consider how a Head & Shoulders formation is expressed in the RSI chart.
The upper part of Figure 2. 1 5 shows the H&S formation in price. The rally could be
labeled a 5-wave advance, with the head being final Wave 5 up. The lower part ofthe
chart is the corresponding RSI graph.
64

At the beginning ofthe chart, the RSI is in bullish territory, rising within its ascending
channel, while prices keep moving up. I am sure thatwe could find some (DD+) signals
in this channel. At Point 3, the RSI hits 80 and a (DD+) signal is formed at Point 4. The
RSI rise after this (DD+) fails to take the RSI into the next segment and a lower high
occurs in the RSI, while prices still reach a higher high, [the price target for the (DD+)].
Now we see the start of a negative divergence. Next, we see the RSI drop below its
ascending channel. This provides us with a warning that something is happening, as we
may now see the start of a descending channel, defined at the top by the negative
divergence.
As long as (DD+) forms at the bottom ofthis descending channel, the trend remains up.
A (DD+) forms at Point A in relation to Point 2. However, we know that the RSI will
end up inbearterritory ifit stays within this descending channel. From this (DD+), the
RSI rises, but fails to break out from its descending channel and prices reach a lower
high forming the right shoulder ofthe H&S.
As the RSI reverses down, failing to escape from its descending channel, it drops below
40 and enters bearish territory. This corresponds to prices dropping below the H&S
neckline (or, cup-line or wedge) and the price decline accelerates. As the RSI bounces
offofthe bottom ofits descending channel, just prior to Point X, it develops a modest
(DD+) in relation to Point 2, but it is well within bearish territory.
The RSI climbs to Point X, while price barely moves because the RSI is still well below
40. When the RSI reverses down from Point X, prices move lower quickly. As the RSI
hits mathematical resistance, it starts towrinkleup, forming a modest positive divergence
into Point Y. The corresponding price rise is not convincing and results in a (DD-) signal
relative to Point X. So there you have it: the RSI remained trapped in its descending
channel and ended up in bearish territory.
As the (DD-) takes effect, it signals that the downtrend is in force. At this stage, ifthe
RSI manages to climb to the top ofits descending channel, it will still only reach a value
of60 at that point and another (DD-) may be developing. In other words, Line X -Y in
the RSI could be the start of an ascending channel dominated by consecutive (DD-)
signals, until the RSI reaches bullish territory andthe first (DD+) is detected.
What would the alternate scenario (e.g. a negated H&S formation) look like in the
RSI? I refer to Figure 2. 1 6.
6S

Walter J. Baeyens
Figure 2.16 HEAD & SHOULDERS ••••
•
•
• t•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
••• • ••
•
Up to Point B, we have a shallow retracement, which should be followedby a resumption
ofthe uptrend and send prices to new highs. (This scenario is pictured by the dotted
lines in the price and RSI charts).
Let's return to Point A (A' in the RSI). There is a (DD+) here in reference to Point 2.
However, following this signal beyond Point A', the RSI stays within its ascending
channel, which is parallel to (but lower than) the original. As the RSI remains above
40, any rise in RSI value will push prices higher. As the RSI value breaks to the upside
from its descending channel, thus ending the negative divergence, it will head higher,
(probably to the 80-level again), and push prices to a higher high.
Until the RSI break-out, it was not clear which channel the RSI would follow as it was
moving within a triangle. Such triangles often center on the 50-line in the RSI and signal
the indecision in the market. The RSI continues up within its ascending channel, and
the new (DD+)s will soon appear, while prices rally to new highs. In fact, we see a
recreation of what happened earlier in the first ascending channel. In this alternate
scenario, the RSI dropped disproportionately past Point 5, only to resume its ascending
channel from a lower level. This is the definition of a (DD+) buy signal.
66

Conventional wisdom tells us that H&S formations, wedges, and cups & handle
formations have the greatest effect when they fail.
PART V
THE NATURE OF PRICE/RSI DIVERGENCES
Now that the concept of (DD) and their signals are understood, our discussion can
revert to Price/RSl divergence.
Let's examine the Russell 2000 Index charts. The first RUT chart (Figure 2. 1 7) shows
the daily time frame. Within the rectangle, there is a steep two-phase drop in price,
pushing the RSI value down to the 26-level in the first phase, then to the 26-level again
in the second phase. Why does this divergence occur? The initial price thrust severely
depresses the RSI, because there is a big change in price behavior when it is compared
to the previous 1 4 days. Just before the price correction in May, price was moving up
in steps and the RSI value was traveling in a range between 50 and 70.
o 47.19 52.40 57 3:3
ru
Created wth TladeStetion
Figure 2.17 Daily Russell 2000
Relatively speaking, the initial price drop caused the biggest change in momentum;
hence the low in the RSI value soon after the start ofthe price correction down. As the
price decline continues for 1 0 days, the price points include down days in the RSI
calculation on Day 1 1 . Day 1 2 is another down day. When the new price data is fed
67

Walter 1. Baeyens
into the RSI equation, the resulting relative momentum figure will be less spectacular
thanthe initial RSI readings. This is why it is sohardto push the RSI pastits mathematical
resistance levels. On Day 14 ofthe RSI period, a persistent downward price momentum
is required, one that is stronger than it was for the last 1 3 days. As soon as the price
decline subsides, we know what to expect.
In mid-May, the RSI value flattens out at the 26-1evel because there is no significant
extra downward momentum compared to the average of the last 1 3 days. When the
first up day is seen in the second half ofMay, the RSI compares the up data from that
day to the average (down) data ofthe previous weeks and reveals a surprisingly high
value. Obviously, after 1 3 down days, a moderate price rise causes a relatively big
change in momentum. As a consequence, the RSI jumps, despite the fact that the
corresponding price rise is modest. This is how (DD)s are formed.
When the price drop resumes in the first days of June, there is another big change in
momentum compared to the average of the last 1 3 days. The mild rebound in price
causes such an out-of-proportion jump in the RSI value that the subsequent RSI drop
only reaches the 26-level again, creating a positive divergence. The key to the formation
ofthe positive divergence is, to a great extent, the amplitude ofthe price rebound. After
a minor price rebound, causing less of an RSI value jump, the next wave down could
have taken the RSI to a lower low.
Averages 0 39.72 '0.13 4387
4125 '117 5Al1 5.Q3 5.C5 5.()9 5M 5n2 inS Ina 5122 5fl4 5J26 5JJ1 SAJ1 6AJ5 6.()7 6.00 6/13 6/15 6/19 6J2O 6122 21)30
770.00
760.00
75O.oo
HOOO
720.00
710.00
20.00
10.00
o
Deoted ..., T,acieSloIion
Figure 2.18 Hourly RUT, covering the same time period.
68

In the hourly chart, the RSI reaches its minimum value at the 1 3-level earlier than the
daily RSI. The biggest change in momentum, compared to the average of the last 1 3
hours, is the transition phase from a price rise to a deep price drop. Once the price
decline exceeds the 14-hour duration ofthe calculation, any subsequent price drop will
be compared to an already negative price momentum. This means that the outcome of
the RSI calculation will tend to produce less extreme values. Past that point, any
weakening ofthe downward pressure on prices, and certainly any minor price rebound,
will cause the RSI value to pop up, which leaves more room for the RSI to go down
when it reverses down again.
The first arrow in the hourly RSI chart marks the point where the RSI value reaches its
low at the 1 3-level. Each of the arrows marks the point where a mild price rebound
causes a (DD) up in the RSI, which is followed each time by a price drop insufficiently
deep enough to push the RSI back down to its previous low. Ofthe initial price drop,
only about halfthe down leg causes a consistent decline in the RSI; the other halfofthe
price drop corresponds to slowly rising values in the RSI.
The main reason for the consecutive higher lows in the RSI, marked by the arrows, is
the minuscule price rebounds, which cause the RSI to rally. When this price rebound
occurs closer to the RSI extreme, it has more effect on the amplitude ofthe RSI move.
Consider the huge impact the initial price rebound has in the RSI at the first arrow. It
becomes clear that the price move up required for a positive divergence in the hourly
time frame is much smaller than the move up required in the daily chart. In fact, what
looked like a straight down market in the daily chart turns out to be a staircase sell off
in the hourly time frame. Each time the down pressure relaxes, the RSI moves up a
notch. Obviously, positive divergence does not necessarily lead to uptrends.
69

Walter J. Baeyens
RSl Averages 0 41 .75 40.8.344 19
90.00
Cleated with T,odeSla/ion
Figure 2.19 30-Minute RUT
This is a close-up picture ofthe initial phase ofthe price decline shown earlier in the
daily and hourly charts. Again, the initial price drop causes the biggest relative change
in momentum. Also, the price rebound required to start the formation of a positive
divergence is even smaller than it was in the hourly chart. In fact, with the RSI value
near its low at the I I -level, a mere price consolidation (shown in the ellipse) is sufficient
to propel the RSI value up to much higher levels.
Under these conditions, even the smallest hesitation in the downtrend causes the start
ofa positive divergence in this time frame. What seemed to be a straight price drop in
the daily time frame (and even in the hourly chart) turns out to be a staircase decline in
the 30-minute chart. From this time perspective, every price consolidation is sufficient
enough to cause a jump in the RSI value, causing a positive divergence. Once again,
we touch upon the subject ofTirne Frame Correlation! What looks like a vertical price
decline in one time frame may be a staircase decline in a smaller time frame. We also
knowthat minimal up-moves in price may cause the start ofa positive divergence in the
smaller time frame.
In this respect, the positive divergence in the smaller time frame warns us thatthe price
decline was not as bad as it may have looked in the larger time frame. But this does not
meanthattiny price corrections to the upside in the smaller time frame will growto the
size required to cause a positive divergence or a trend change in the larger time frames.
70

Ifthis picture could be zoomed in further to the 5-minute time frame, I am sure that the
positive divergence would start even sooner. After the initial dive to its low point,
minimal hesitations in the downward pressure on prices cause the RSI value to begin its
upward travel to the point where it rises above the 40-level and enters bullish territory.
We may even find a (DD+) signal prior to the price correction up that caused the start
of the positive divergence in the daily chart. For the 5-minute traders, the positive
divergence led to an uptrend in that time frame, (DD+) included!
In a downtrend, minorup-moves in price may cause the formation ofa positive divergence
in the small time frames, but sizeable price moves to the upside are required to cause
the trend to change. However, what is only the start of a positive divergence for a
longer-term trader may represent a full-blown uptrend for another trader who has a
shorter-term outlook. The price moves required to start positive divergence in the
larger time frame are of such a size that they cause (DD+) signals in the smaller time
frames, propelling the RSI value into bullish territory. This also illustrates my point that
the "trend" can hardly be defined in absolute terms. In fact, it is time frame specific.
A 54.00
53.00
52.00
51.00
SO.OO
Y 49.00
48.00
RSIAvereges 0 40.99
00.00
80.00
70.00
60.00
SO.OO
30.00
20.00
10.00
20:15 1110 18:45 1 f1 1 19:45 11t2 18:15 1116 19:15 1117 17:45 20:15 11'16 1 8:45 1119 19:45 1(22 18'15 1 123 19:15
( iii [JJ
Cleated with TradeSlation
Figure 2.20 LRCX I 5-Minute
This chart offers an extreme example of the occurrence of a (DD) and positive
divergence. At Point B, the main look-back period for the RSI calculation (3.5 hours
from 14 periods of I 5-minutes) extends to Point X. This means that the price move
from PointA to Point B is being compared to the price activity between Points X and A,
resulting in a major relative momentum shift downward. The RSI value hits the 1 0-
level at Point B'. At Point D, the RSI look-back period extends to Line Y. The momentum
between Points B and C is down. Compared to this situation, the modest price rebound
from Point C to Point D is significant, relatively speaking. As a result, the RSI value
71

Walter J. Baeyens
jumps to the 60-level, nearly reaching the value ofPoint A'. The move up in the RSI to
Point D' is massively out-of-proportion when compared to the drop from Point A' to
Point B'.
Past Point B', the mere flattening outofthe price drop results inan important momentum
change compared to the extreme negative momentum found just a few hours earlier.
This is the cause ofthe positive divergence at Point B ' and Point C'.
PARTVI
RSI SIGNALS REVISITED
The buy and sell signals advocated by Andrew Cardwell make sense. Additionally,
there is some logic to interpretingthemwithin the frameworkofascendinganddescending
RSI channels ofvarious sizes. I propose to reevaluate these signals and check the limit
oftheir validity. When we are done, we should be able to formulate some general rules
regarding the interpretation and the validity ofthe RSI signals that we have discussed
so far.
We should look for the presence ofrelevant segments or channels in RSI charts, which
are: descending channels anchored on (DD+) buy signal reference points (uptrend) or
ascending channels anchored on (DD-) sell signal reference points (downtrend). These
channels will provide valuable reference lines, as future RSI channels will be nearly
parallel and, as we have learned, the RSI will be slipping fromone channel into the next.
We have also learned that ascending channels will take the RSI values from bearish
territory into bullish territory, while descending channels will cause the RSI to reach
bearish territory, unless the RSI manages to break out. This is a key point - several
important things happen when the RSI moves from one type of channel into another.
We have briefly discussed this topic, but let me repeat the basics here as I refer to
Figure 2.2 1 .
72

Figure 2.21
A
- - -
- - -
- - - - - -
- - -
. -
- - -
- - -
- - -
- - -
- - -
--
.".. --
--
--
."..
.".. ."..
."..
."..
.".. --
- - -
- - -
Let's assume that a (DD+) was detected in this RSI chart at Points V and W, while at
Points A and B, a negative divergence was found (meaning prices are higher at B than
at A). Upon closer examination, we find that this negative divergence has pushed the
RSI below its previous ascending channel (bold dashed line). The RSI reading at Point
A is over 80, which is why a negative divergence developed as prices continued to
movehigher.
We have found the traces ofa bull market, namely a descending channel with a (DD+),
anchored on Points V and W. This descending channel will lead the RSI into bearish
territory by continuing down. Following the (DD+), the RSI rebounds to Point C, where
corresponding prices move slightly higher.
Prices retrace modestly past Point C, while the RSI drops rapidly to Point X, where it
reverses up. A new (DD+) is formed in relation to Point W, as prices have been
climbing the whole time. The market is still in bullish territory. Let's say that the RSI
value at Point X is 45. The surge past Point X takes the RSI back tothe upper boundary
of its channel, but prices only reach a lower high at Point D. From Point D, the RSI
returns to the lower boundary ofits descending channel. PointY is well below the RSI
40-level and the corresponding price retracement is deeper than the previous one.
As the RSI reverses from Point Y, there is no longer a (DD+) signal. The last price
drop was not shallow. Now, we have a descending channel without (DD+) as the RSI
enters bearish territory. The bullish character ofthe channel is lost because the RSI
fails to break out from this channel in time. With the RSI rebound into Point E at a value
of60, prices hardly move up. Here we see the formation ofa first (DD-). The reversal
73

Walter 1. Baeyens
down from Point E takes the RSI value to the 20-level as price accelerates its decline.
We began with a bullish RSI signaland ended up withprices dropping. Whathappened?
Where does the switch-over occur?
We cannot say that the negative divergence caused the price drop. It merely pushed
the RSI below its original ascending channel. However, this resulted in a new (DD+),
so the bullish character ofthe channel remained intact up to that point.
The RSI should have broken out from its descending channel to safeguard the uptrend.
For instance, from the (DD+) at Point W, had the RSI stayed within the potential
ascending channel by staying above the dotted line, the RSI would have escaped from
its descending channel and new (DD+)s would have confmned the continuation ofthe
uptrend. The same scenario occurred past Point X, where the RSI broke below its
potential ascending channel at Point Q and entered bearish territory.
This teaches us about the validity of the (DD+) signal. For a (DD+) to take e
ff
ect,
the RSI has to stay within its ascending channel a
fter the signal occurs. In other
words, the RSI has to break out upward from its descending channel.
If the RSI fails to do this while it is still in bullish territory, the consequences are not
dramatic; it will probably form another (DD+) at a lower level. The difference with the
prior (DD+) is that the price target for the latter signal is lower. In other words, the RSI
is signaling a flattening, or weakening, ofthe uptrend.
Related to the validity of a (DD-): For a (DD-) to take e
ff
ect, the RSI must stay
within its descending channel a
fter the signal occurs. In other words, the RSI will
have to break below its ascending channel.
In our example, this is what happens after Point E, when prices reach lower lows. If
the RSI fails while it is still in bearish territory, the consequence is nota change in trend;
rather, it leads to the potential for a new (DD-) at a higher level. The price target for
this new (DD-) will be higher than the previous one, indicating that the price decline is
bottoming out. In either case, there is a switch-over point where the RSI enters the
opposing territory and countertrend orreversal signals startappearing. Not surprisingly,
in some cases these coincidental RSI signals turn out to be contradicting.
74

Figure 2.22
- �Q _ - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
Figure 2.22 illustrates a typical ascending RSI channel.
In Figure 2.22, Points X and Y are both situated in bearish territory with values below
40. Apositive divergence is building as price at Point X is lowerthan at Point W. Points
A-B-C are higher highs in the RSI, but prices show lower highs, hence the (DD-)
signal. The Line A-B-C defines the upperboundary ofthe channel at its origin. For the
(DD-) to take effect, the RSI needs to break below its ascending channel or stay within
a descending channel after the formation of a (DD-). At Point X, prices may even
reach the target ofthe (DD-), ifthe positive divergence is really steep.
As the RSI value fails to drop below its ascending channel at Point Y around the 40-
level, prices reverse up from a higher low. Above the 40-level, a rise in the RSI
corresponds to a rise in prices and the price difference between Points Y and D is
markedly larger than the price difference between Points W and B. The RSI fails to
drop below its ascending channel and ends up in bullish territory, as the price decline
bottoms.
At Point Z, the RSI reverses up again and price breaks above the (DD-) Lighthouse
level, invalidating the (DD-). The price rally between Points Z and E is considerable
75

Walter 1. Baeyens
and the shallow retracement into Point F causes the formation ofa first (DD+) within
the ascending channel.
Past Point F, the RSI value pops into the next RSI segment and the rally accelerates as
the RSI value rises well above 65. A negative divergence may form within this channel
ifthe rally continues. Then, we could see the descending channel scenario unfold.
In the Figures 2.2 1 and 2.22, the RSI travels within its descending or ascending channel
from one extreme to the other. In reality, the RSI does not need to reach its extremes
to switch channels. Now that we know how to check the validity ofthe (DD) signals,
we can look at what could happen when the RSI breaks out of its channel somewhere
between extremes.
Figure 2.23
In Figure 2.23, the RSI is meandering within its descending channel up to Point V.
Here it drifts towards the upper boundary and breaks out of the channel at Point X.
Imagine that at Points X and Y, a FAST (DD+) develops. For this to remain a valid
signal, the RSI must stay above the line drawn from V to Y, or the RSI will need to
remain within its new ascending channel after Point Y. Ifit does, it is possible that the
RSI could continue up to Point Z, where a new (DD+) or even a FAST (DD+) could
form as prices rally higher. Fromthatpoint on, the RSI could follow hypothetical Path
A in this bullish scenario.
76

Let's assume that the RSI does not rise into the next channel segment at Point Z on the
dashed RSI line. Instead, the RSI reverses downward and drops below the line from V
to Y, invalidating the (DD+) created at Points X-Y. Does this activity mean the end the
rally? Not necessarily. If this RSI break-down from Channel V-Y occurs high in bull
territory, we can expect the RSI to form a new (DD+) at Point W, in reference to Point
y
The price target for this new (DD+) will be lower than the previous one at Points X-Y,
indicating that the rally may be losing steam. In this scenario, the RSI would have to
stay above a line through Point W, parallel to Line V-Y (not shown). Ifthe RSI fails, as
shown in the example above, we must conclude that the RSI is moving within a
descending channel again and will form a (DD-) within this channel. In this example,
the RSI popped out ofits descending channel, only to continue down in a new (parallel)
descending channel.
Another hypothetical scenario would be that the RSI breaks below Channel V-Y, and
the RSI bounce at Point W does not produce a (DD+). This means that the RSI break
downmusthave coincided with a relatively deep (as opposedto "shallow") price decline.
In this case, we will see the formation ofa (DD-) as the RSI continues down.
Let's summarize what we have learned. In a bull market, if the RSI drops below its
ascending channel after hitting normal resistance near 75 to 85, assume that the RSI
will form a new (DD+) when it reverses up. In a bear market, if the RSI breaks out
from its descending channel after hitting resistance near 25 to 1 5, assume that it will
form a new (DD-) when it reverses down.
In a strongly trending market, assume that the retracement in price that causes the RSI
to break down or break out will be shallow. This will lead to a resumption ofthe main
trend. If the break-down or break-out in the RSI does not lead to the formation of a
(DD) signal, this means that the retracement threatened the trend in that time frame.
We will need to monitor which channel the RSI will take and wait for the formation of
a new (DD) signal. If the next (DD) signal is contrary to the trend, the retracement is
incomplete and the continuation ofthe retracement may even cause the trend to reverse
in that time frame.
Let's apply what wejust learned in another example, Figure 2.24. We have detected a
(DD-) along the top boundary ofthe Channel X-Y-Z. Prices cascade down, while the
RSI is curling up in a positive divergence. At Point Y, the RSI value fails to drop below
its ascending channel. As this is still bear territory, it does not mean the bear phase of
the market is over. Prices still reach new lows, but the RSI stays in its ascending
channel. At Point Z, it reverses up again from the 40-level and prices reach a higher
low. Past Point Z, the channel loses its bearish character as the RSI rises to bullish
levels. At Line A, a first (DD+) appears. The RSI stays within its ascending channel
and prices rally to a new high. Negative divergence occurs as the RSI reaches the
upper boundary of the descending ChanneF. Note that the top line of this ChanneF
defines a negative divergence since April of2006.
77

Walter J. Baeyens
. Doiy A.EX Lo10.42 .0.00 .0.00% 8010.30 A·11XXl.00 0.0.00 �.o.OO Lo:O.OO C·1O.42 V.o
11.00
Averoges 0 59.68
Figure 2.24 Daily NKS
00.00
00.00
70.00
bUill
40.00
30.00
- - - - - - - - -
=
PosDiv
-
- - - - - - - - _ _
10.00
.00
Oct
Deatedw<hT,adeSlaiion
Negative divergence pushes the RSI below its ascending channel in the first week of
September. This activity invalidates the (DD+) detected at Line A. But since the
RSI is in bullish territory, this drop results in a new (DD+) at Line b (for now), as shown
in Figure 2.25. For this (DD+) to be valid, the RSI must stay within its (new) ascending
channeL
The early channel, defined by points X, Y and Z, is too narrow to be counted as a
channel, so the ascending channel is redefined in Figure 2.25. This new, wider ascending
channel makes sense as welL At its upper boundary, it is anchored on the reference
points ofa (DD-) and at its lower parallel boundary, it provides a reference line to check
the validity ofthe (DD+) signal at Line b.
78

A....erages 0 59.68
CHANNEL'
Figure 2.25 Daily NKS
1 1 .00
10.80
10.60
1011)
10.00
9.80
9.60
9.40
"-
90.00
��
- - - � � - - - - - - - � - - -- - 20.00
10.00
0.00
Aug Oct
Createdwth Tr�tation
The original ascending channel from X to Z is a sub-channel, and the (DD+) at Line b
is the RSI transition into a new ascending sub-channel, starting from a lower level.
After rebounding off a channel bottom, the RSI appears to be forming a steep and/or
narrow channel. This is the case in March 2006. By connecting the initial lows in the
RSI, a channel appears; one that is not parallel to the previous channels because it is
much too steep. This indicates that a sub-channel up is forming and that another sub
channel down will bring the RSI to the bottom ofa realistic ascending channel, which is
parallel to the well-anchoredprevious channels.
On another level, namely from the ChanneF perspective, we can say that this picture
looks familiar. We saw a descending ChanneF featuring negative divergence earlier,
but there is no (DD+) at Point X in relation to the low in March 2006. This means that
the RSI, which failed to break out from its descending ChanneF, has entered bear
territory. Indeed, the value at Point X is near the 25-level and the top ofChanneF is at
the 60-level. The (DD-)just detected is obviously the first (DD-) within this descending
ChanneF.
This could be considered a reversal signal. It corresponds to the Head & Shoulder
scenario that we studied earlier. As it turns out, there is indeed a giant H&S formation
visible in the price chart! It is clear that the RSI needs to break out from its ChanneF in
order to avoid the effect ofthe (DD-).
79

Walter 1. Baeyens
Now let's return to the ftrst (DD-) discovered, the one labeled X-Y-Z. The origin ofthis
(DD-) inthe RSI corresponds to Point 0 1 (Origin 1 ) in price. Within this initial ascending
sub-channel, we notice that the RSI fails to break down at Point Z. The consequence
is that the RSI enters bullish territory. After prices start their climb, they exceed price
Level 0 1 , invalidating the initial (DD-). Remember, in the price chart, a (DD-) is
formed at a lower top, but once price exceeds the level ofthe first reference point of
the signal, the signal is no longer valid.
So, the initial (DD-) becomes invalid as price exceeds Level 0 1 . No wonder we see a
(DD+) appear within this channel at Line a as prices reach Level 0 1 . However,
following this (DD+), the RSI fails to continue upward and drops below its channel.
Why? The ChanneF top line forced it into a negative divergence. As the RSI drops
below its channel and forms a new (DD+) at Line b (note that the price target for this
signal is lower than at Line a), we discover the real channel of interest.
This larger ascending channel is anchored on the reference points ofa (DD-), which (in
price), has its origin at Point 02 (Origin 2), so this (DD-), which was labeled "reversal
signal" earlier, is still valid. In price, the Level 02 could be considered a resistance line.
This is the level that defines the right shoulder ofthe giant H&S formation discovered
when analyzing the RSI behavior in relation to its ChanneF. Price levels such as 0 I
and 02 will be labeled Lighthouse levels, originating at Lighthouse points in price and
RSI. It is clear that, by definition, a (DD+) or (DD-) becomes invalid when price breaks
the signal's Lighthouse level. Why this label and what does it mean?
80

Figure 2.26
A
PART VII
THE RSI LIGHTHOUSE
RSI LIGHTHOUSE
Lighthouse level
• . . . . . _ . - . . . . . . . . . . . . _ - .
, ... .. .
, ... ..
, ... .. ..
, .. ..
B
... ..
, .. .. .. ...
.. .. .. ..
x
� �
- - - -- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -,�
�
c
20
8l

Walter 1. Baeyens
Figure 2.26 provides a graphic illustration of the "Lighthouse level" concept. This
chart has a (DD-) signal at PointsA, B, C in the RSI, with the corresponding ascending
channel anchored on its reference points. The lower boundary ofthis channel defines
a positive divergence. The (DD-) signal at Point A and Point B leads to a price decline
ofthe price target level. Following the second (DD-) at Point B to Point C, the RSI fails
to break below its ascending channel and rises further, into bullish territory. The price
decline bottoms out and price reverses upward. At Point D, price is still lower than at
Point A, while the RSI is higher at D than at A. There is still a valid (DD-) signal
between Point A and Point D. In the price chart, drawing the corresponding lines
[connecting the (DD-) reference points] gives us the impression that Point A IS a
"lighthouse" shining over the price "landscape" below.
It is clear that the limit ofthis (DD-) will be reached when prices exceed the Lighthouse
level, which is considered resistance, as it marks the limit ofthe validity ofthe (DD-).
Figure 2·27
40
A Lighthouse level
B
80
... ... ..
... .. ..
- .
Figure 2.27 is an inverse picture ofthe (DD+). The price low where the (DD+) signal
originates is labeled the (DD+) Lighthouse. The reference lines ofthe RSI signals can
be transferred onto the price chart.
82

PART VIII
(DD)-BASED SUPPORT & RESISTANCE LINES
Figure 2.28
TGT = ( B· A ) + C
RSI (14 )
( DO + )
.. ...
.. .. ..
... .. ...
TGT = Z· ( X·Y )
( DO . )
... ... ..
... .. ..
... .. ..
Figure 2.28 shows a hypothetical up-and-down cycle in price with the corresponding
RSI chart. The (DD+) signal and (DD-) signal, with their respective price targets, and
the method ofcalculation, are also shown. When a (DD+) signal is detected in the RSI,
the price reference points are connected, therefore defining a price support line.
While observing the price target calculation, we see that the price target is situated on
a line parallel to the (DD+) support line. The difference in price between Point B and
Point A is added to the price high. In this example, price reference points A and B are
83

Walter J. Baeyens
connected to define price support Line A-B. From the price reference Point C, a
parallel line is drawn. The price target for the (DD+) signal is situated on this line. The
(DD+) based lines define a climbing price range. These lines are used as a reference
for the evaluation ofthe validity ofthe (DD+).
At the (DD-) at Point X and Point Y, the price reference points are connected to obtain
resistance line X-Y. The price target for this (DD-) is situated on the parallel line
originating at Point Z. These lines define a declining price range, which provides a
means for determining whether the (DD-) signal remains valid.
PART IX
VALIDITY OF (DD) SIGNALS
Let's take another look at the validity of (DD) signals and the definition of the price
support line, based on the (DD+) price reference points.
Figure 2.29 (�O) VALIDITY
TGT = ( B· A ) + C TGT = Z· ( x·Y )
RSI ( 14 ) NegOiv
( DO · )
( DO + )
In Figure 2.29, the (DD+) signal at Point A and Point B (in the RSI) takes effect ifthe
RSI remains within its ascending channel. (The ascending channel I reference is the
84

line parallel to previous channels, from Point B in the RSI). This line passing through
Point B is the lower boundary ofthe ascending channel referenced for this (DD+).
Past Point B, the RSI stays in its channel and continues to climb. At Point P, the RSI
slips into the next segment as price continues to rally. Finally, we seeprice topping out,
while the RSI indicator is diverging with price. This negative divergence leads the RSI
to the lower edge of its ascending channel, and at Point Q, the RSI breaks below its
ascending channel. We can say that the validity of the (DD+) signal at Point A and
Point B ends when both price andthe RSI have broken below their respective ascending
reference lines. In this example, the (DD+) signal becomes invalid, but is not bearish.
After all, the (DD+) price target was exceeded. It is important to look for a new
(DD+) that will provide new reference lines.
Assuming that the high RSI value at the start ofthe negative divergence will be around
the 80-level, the RSI break-down should lead to the formation of a new (DD+) at a
lower level. In Figure 2.29, a hypothetical chart, the RSI drop leads to a (DD-). However,
this is not realistic, as the "synthetic" Point B and Point X in the RSI are at about the
same level. [Point X is at the origin ofa (DD-); it should have been at a lower level than
Point B). So much for artificiality!
Figure 2.30 fDO) VALIDITY
TGT = ( B- A ) + C TGT = Z- ( X-V )
RSI ( 14 )
( OD - )
w B
( 00 + )
... -
.. ... - - ...
- ... ..
"' - ..
"' - ..
We refer to Figure 2.30 for an assessment of the validity of the (DD-).
8S

Walter J. Baeyens
The (DD-) signal at Points X and Y will take effect when the RSI stays within its
descending channel. At Point Y, one can draw a line parallel to the previous channels
(to LineA-B in this example). This line is the upperboundary ofthe descending channel
and is a required reference line. At Point V, the RSI fails to drop into the lower RSI
segment. As a consequence, the RSI continues up and breaks out of the descending
channel. Price rebounds, but it does not break the price resistance line. The initial
(DD-) signal at Points X andY is not invalidated. However, as the RSI continues up, the
formation ofa new (DD-) on the extended line X-Y is probable.
Ifthe RSI continues up, the formation ofa (DD+) in the ascending channel could mark
the resumption ofthe rally. This analysis leads us to the following conclusions about the
validity of(DD) signals:
(DD+) and (DD-) signals remain valid until the RSI exits its re
ference channel
and price breaks the (DD) based support/resistance line. The (DD) signal ceases
to exist when price breaks the Lighthouse level of that signal.
The invalidation of a (DD) signal is not a direct indication of a trend reversal in
that time frame. Most of the time, the invalidation of a (DD) leads to theformation
of a new (DD) of the same type, but with a more modest price target.
I need to mention a special circumstance of the effects of Price/RSI divergence. In
some cases, price will break the (DD) reference line, (whether or not it is a support or
resistance line), and the RSI will not break the validity line. When this occurs, the (DD)
signal remains valid. These conditions can exist when a Price/RSI divergence causes
price to break the reference line, while the RSI remains within its channel. However, in
such cases, this RSI behavior leads to the formation of a conflicting (DD) signal. In
such cases, both (DD) signals remain valid until one is invalidated by the effects ofthe
other.
PART X
FAST (DD) SIGNALS
The (DD) signals always consist oftwo reference points in the RSI. This means that
two RSI extremities are needed at tops or troughs in order to define a (DD) signal.
However, we learned that a series of (DD+) signals or (DD-) signals often develop in
a trending market. In a bull market, we get a sequence of (DD+) signals within an
ascending ChanneF. After the initial (DD+) signal (reversal signal) occurrs, the RSI
will pop into the next up-segment every time the price rally enters a new phase. We
also know that (DD+) signals remain valid until the RSI drops below its ChanneF. This
allows a new type of (DD+), namely the FAST (DD+), for which we need only one
RSI extremity.
86

Figure 2.31
FAST (00+) SIGNAL
..'
.
.
.
.
.
.,.'
,
..,.......
, ""
,
....
.
.
..
.
..
..
.
•..
.
...
.•.....,.
.
.•
.
...
.
...
. .
. .
.
.
.
.
.
.•. .
..
.....
.
.
..
.
.
.... .... t
. •
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' . � ,
,
.
.......
, "" A2
Figure 2.31 provides two examples ofFAST (DD+) signals at Point X and PointA, X l
and A l . Suppose there is a (DD+) signal at the beginning ofthis chart, above the 40-
level, with anestablished ChanneF lowerboundary. Weknowthat price is going up, as
long as the RSI stays above this ChanneF reference line. Logically, we should see a
series ofvalid (DD+) signals develop on or above this line.
When the RSI breaks out ofits initial (DD+) segment (at Point X), we know the price
rise has entered a new phase. When the RSI reverses up from PointA, the corresponding
price will be higher than at Point X. This is another (DD+) signal. Similar conditions
exist at points X l and A l .
Any time that a line can be drawn through Point A I, parallel to an earlier (DD+)
descending channel, and price at A l is higher than at Xl, a FAST (DD+) has
been detected.
If the first (DD+) signal is missed, it is not necessary to wait for the formation of
another "normal" (DD+), requiring the occurrence of two RSI extremities. If after
PointA I , the RSI fails to stay above Line A-AI , prices will remain above their level at
Point X I , as long the RSI reverses up from the ChanneF boundary. In this example, the
RSI reverses up at Point A2; it can be assumed that price at Point A2 is higher than at
PointA l , so this is a classic two-point (DD+) signal.
In a downtrend, FAST (DD-) signals can be detected by using one RSI extremity and a
line running parallel to an earlier (DD-) ascending channel.

Walter 1. Baeyens
An example ofa FAST (DD+) is found in the Oil Index chart examined earlier in the
context ofpositive divergence and its consequences. The second positive divergence,
starting in February of2003, defines the bottom ofan ascending channel, within which
a first (DD+) appears by the end ofApril. In early May 2003, the RSI value breaks out
and pops into the next RSI segment, forming a FAST (DD+) well above the 40-level. A
classic (DD+) is not present; although, it may appear by the end ofJune, when the RSI
will probablyreverse up from its Channe)2 as the rally continues.
Please note that two RSI extremities in a smaller time frame moving average define a
FAST (DD+) signal in a larger time frame. With a FAST (DD+) signal, it is sometimes
difficult to determine the exact price that corresponds to the reference crossing point in
the RSI. Switching to a smaller time frame allows the price level to be determined.
Also, you might even find the corresponding (DD) signal in that time frame is near two
RSI extremities.
88

PARTXI
PATTERNS IN THE RSI
RSI Triangles
Triangle fonnations in RSI charts are not rare. As the RSI travels within its multiple
channels, it constantly hits lower or upper channel boundaries, where it either breaks
out or reverses its course. Ifwe draw the signal reference lines in the RSI chart, [(DD)
reference lines and (DD) validity lines], a matrix is obtained within which the RSI is
meandering. Sometimes, the fonnation of a triangle in the RSI chart indicates that a
significant point has been reached.
The (projected) apex ofthese triangles is situated on or near the RSI value of 50. The
50-level marks the point where bullish and bearish forces balance. As the RSI progresses
within the triangle, the market's indecision becomes more and more visible until the RSI
breaks out ofthat triangle. This type oftriangle is often observed when two contrary
(DD) signals exist in the same time frame.
Such a situation can only existwhenthe RSI is moving in andout ofbullish and bearish
territory around the 50-level andprices are moving up and down, triggering bullish and
bearish (DD) signals in succession. Ultimately, the balance of the market shifts one
way or the other and, as is the case with price triangles, the break-out or break-down of
the RSI often causes important price moves, or even a trend change, within a time
frame.
IAJSO -'Weekly fOREX L"1.:3151 +0.0021 ...0.16% 6-1.3151 A-1.3154 0-1.3132 HI.1.3163 Lo-1 .3119 C-1.3151 V-O
1.100)
1 .0500
1 .0c00
0.9500
AverageS 0 65.55
- - -
- - -
- - -
- - -
- - -
20.00
999
rn
Created with T,ade$talioo
Figure 2.33 Weekly EURIUSD
89

Walter J. Baeyens
In 1999 and 2000, the RSI is meandering within a descending ChanneF as prices slide
lower. By the end of 2000, a (00-) signal forms within this descending ChanneF,
which is typical of a bear market. In Quarter 3 of 200 1 , the RSI reverses down after
hitting the upper boundary ofthe descending ChanneF, indicating that the (00-) signal
is still valid and that the RSI is apparently staying within its descending ChanneF.
However, following this (00-), the RSI fails to break below its ascending channel and
finally ends up on the edge of bullish territory around the 40-level. The indecision
caused by the RSI is reflected in the formation of a large triangle, with the RSI value
zeroing in on the 50-level. The RSI break-out to the upside and the appearance of a
(00+) mark the start ofthe uptrend.
Weekly C80E L-1386.72 +0.00 +llOOOl. 8-138627 A-1387.22 0-0,00 Ii-O.OO lo-O.OO
- -
rn
Cre�ed 'Hllh Tr�Statioo
Figure 2.34 Weekly SPX
In 2000, after a 5-year rally, the negative divergence pushes the RSI below the giant
triangle that had been forming since 1 999. The triangle is defined by the negative
divergence at its top and the bullish (00+) validity line, which forms the lowerboundary
of the ascending RSI channel. The apex of the triangle is situated near the 50-level,
signaling indecision in the market, questioning whetherto break the negative divergence
or invalidate the major (00+) signal. In the price chart, we see nothing alarming until
prices drop below the bullish (00+) support line, marking the beginning ofa major price
decline. As the RSI value breaks below the 50-level, the RSI enters bearish territory
(after some hesitation) in Quarter 4 of2000.
In early 200 I , the RSI rebounds to hit the underside ofthe triangle. This causes a series
ofbearish (00-) signals, confirming the continuation ofthe price decline. The dashed
90

line defining the bullish (DD+) signal and an imaginary extension of the negative
divergence line serve as the lower and upper boundaries ofan RSI channel.
Note that the example weekly charts of the SPX and EURIUSD both show a trend
change after the RSI breaks from the triangles. In the case ofthe EUR/USD, the trend
changes from down to up, after the transition through the significant RSI triangle. In
the case of the SPX, the trend changes from up to down. In both cases, the relevant
indecision triangles in the RSI form on the 50-level.
The RSI Squeeze
In a strong rally, when the RSI value is in the high 70s, a break-down of the RSI (to
lower values from its ascending channel) may only cause a minor price correction
downward. As the RSI reverses up from a lower level, it forms a new (DD+). At this
time, prices are ready for a rally to higher highs. However, when the RSI is in an
ascending channel, havingdifficulty breakingabove the 60- to 65-level, and is repeatedly
being squeezed toward the channel's lower boundary, be prepared for a steep price
decline when it finally breaks down from the ascending channel.
This pattern is labeled the "RSI Squeeze." It features the RSI, trapped between the
rising boundary ofits ascending channel and the 60- to 65-level. The RSI Squeeze is an
interesting signal that only occurs in the RSI. It is relatively easy to detect and can be
very rewarding.
Figure 2.35
Figure 2.35 RSI Squeeze.
Ifthis rally is to continue, the RSI value must fail to rise above the 60-level. Remember,
bullish RSI territory is defined within the value range from 40 to 80, while 20 to 60 is
considered bearish territory. In this case, the failure ofthe RSI value to decisively rise
91

Walter 1. Baeyens
above 60 is a sign of serious market weakness. Please note that this is not the same
situation as the RSI hitting resistance around the 75- to 80-level, where it is often
compressed to develop a negative divergence with price.
The RSI drop from the 60-level is a situation that would indicate a sudden, deep price
retracement or trend change if the ensuing decline caused the RSI values to enter
bearish territory in the larger time frames. Imagine an RSI Squeeze in the hourly time
frame while there is a rally in the daily time frame. We know that strong momentum in
the daily time frame should easily propel the hourly RSI values into the high 70s and low
80s. If that is not the case, be ready for a quick downward correction. It is possible
that the break-down following the RSI Squeeze could trigger a chain reaction in the
larger time frames. This is how major price corrections and/or trend changes start: RSI
action in a particular time frame triggers a reaction in the larger time frame, not unlike
a falling rock causing an avalanche.
In a bear market, possibly after a (DD-) signal has formed, the RSI Squeeze is
characterized by the RSI refusal to drop below the 40-level. Also, it may get squeezed
between this RSI level and the descending RSI channel. As the RSI pops up from its
channel, the corresponding price movement is likely to be violent.
The RSI Squeeze can be mistaken f
or simple divergence, but it is a much stronger
signal. The key to identifying this signal is the unrealistic level where the RSI value
gets stuck. In the daily time frame, the 60-level is an unusually low value for an RSI in
an uptrend; the 40-level is an unusually low value for a downtrend. In the hourly time
frame, an RSI hang up at the 70-level in an uptrend is an indication ofmarket weakness;
the 30-level in a downtrend is an indication ofmarket strength.
Figure 2.35 shows what an RSI Squeeze would look like in a daily chart. At the beginning,
the RSI is moving up within its ascending channel, forming consecutive (DD+) signals.
At Point B, the RSI fails to convincingly break out ofthe channel before dropping back
to the channel bottom. Price may have reached a new high, but the failure ofthe RSI
indicator to rise above 60 (in an uptrend) signals trouble ahead. AtPoint B and Point C,
the RSI fails to rally above the 60-level. At Point D, the RSI makes a last attempt to
break out before plunging almost vertically, breaking down from its channel.
The scenario at Point D is not a requirement, but it is often observed. In daily charts,
the RSI Squeeze occurs around the 60- to 65-level, which is an unrealistically low level
for the RSI to get stuck in an uptrend. In the hourly time frame, the RSI Squeeze
picture will be identical, but the reference RSI level may be as high as the 70- to 72-
level.
The RSI dives past Point D. Expect the RSI value to initially drop to the extension ofa
previous (DD+) reference line. If the downward correction is "shallow" in the larger
picture, a (DD+) may be formed as the RSI reverses up and the rally may resume.
However, ifthe RSI value drops below 40 (into bearish territory), the next signal may
be a (DD-) signal, or even a FAST (DD-) signal, and the RSI could cascade down as
the price drop accelerates. This is not unlikely, given the fact that the RSI Squeeze
occurs at the 60-level.
92

If the RSI Squeeze and the subsequent RSI drop should cause a (DD+) signal to be
invalidated in the larger time frame, the price slide could extend and cause a (DD-)
signal in the larger time frame as well. This is not an unusual scenario after an RSI
Squeeze. After all, if there was a (DD+) signal in the daily chart, but ensuing price
action was so weak that the RSI failed to rise above 60 in the hourly chart, we should
not be surprised to see the (DD+) signal fail.
In a downtrend, the RSI reference levels will be 40 to 35 in the daily time frame and 30
to 28 in the hourly time frame.
Figure 2.36
.... ... .... ...
o .......
- - - - - - -
�- - - - - - -
40
Figure 2.36 RSI Squeeze in the Hourly Time Frame
... ...
.......
.. ....

Walter J. Baeyens
XJ((D)·60ntl COOl: L=1377.34 +0.00 .0.00% 8=1377.16 A.137B.1B 0-0.00 �.o.oo Lo.o.oo C.1377.34 v.o
20.00
2116 2121 2123 2f27 3.4)1 3.00 3.4)7 3.QB 311 0 3114 3N6 3120 3122 3124 3127 3Il9 3fJ1 4114 4.00 4nD 4N2 4N3 4NB
Figure 2.37 Hourly SPX
� 0
Deoted ..til T,adeSIa!""
This chart offers a nice example ofan RSI Squeeze in the hourly time frame. After the
(DD+) signal on March 2 1 , there is a clearly defined ascending channel. Here we
would expect to see the formation ofnew (DD+) signals as the rally continues.
The RSI is unable to rise above the 60-level, which is quite unusual. In the hourly time
frame, the RSI value should be able to reach the 80-level easily, as it did on March 15.
At Point V, there is a downward break through the ascending channel, invalidating the
earlier (DD+) signal. This type ofbreak is often an early warning that the RSI is going
to leave its channel in the near future. At Point D, the RSI finally seems to break out
and pop into the next slice, but fails again near the 65-level.
At Point X, the RSI finally surrenders and drops below its ascending channel and prices
drop almost vertically. Past Point X, after a minor rebound, the RSI reverses down
from the underside ofthe channel, giving a FAST (DD-) signal, followed by a regular
(DD-) a few days later. The price target for this (DD-) signal was not reached when
the RSI broke out from its descending channel, after being pushed above 40 in the
positive Price/RSI divergence that developed between April 1 1 and 15.
94

YhI(D) - 60 rnil COOT l-12152 -36 -0.30% 8·12151 A·12152 0.12182 Hi-1 2185 lo-1 2152 e-12152 V-1918
RSI Al'eroges () 45.74
Figure 2.38 Dow Jones Industrial Index Futures Contract
This chart provides another example of the RSI Squeeze. The RSI moves within its
descending channel, forming consecutive (DD-) signals. Then, the RSI refuses to drop
below 25 and is squeezed between the upper boundary of its descending channel and
the RSI 25-level. As it pops out ofits descending channel and rises above 40, (after a
final positive divergence), an explosive price rally occurs, taking the RSI well above 80.
In price, the (DD-) Lighthouse levels are exceeded; there is a potential (DD+) signal
around the 40-level, ifthe RSI reverses up onNovember 8.
Next, let's examine a sequence ofthe EURIUSD cross-rate pair daily charts.
95

Walter 1. Baeyens
-0.0,. fOREX L·12780 .0.0056 .0 ..% 6012780 A.12783 0-1 2725 �1 2781 Lo-1 2f5/7 (012780 V-O
Figure 2.39 Daily EUR/USD
1 .3<00
1.3200
1 .3OOJ
1 .2600
1 2<00
12200
1 .2000
11Il00
The ascending channel begins in bearish territory. After a pair ofpositive divergences
at the end of2005, a (DD+) reversal signal forms in February 2006. As the RSI keeps
working higher in its ascending channel, a second (DD+) signal forms in June 2006.
Following this signal, the RSI is unable to rise over 60. This is an unusually low value
for the RSI to remain; the RSI Squeeze signals persistent weakness in the Euro over a
5-month period. In October, the RSI drops below its ascending channel and the Euro
slides from 1 .28 to 1 .25. The RSI reverses upward from the last (DD+) reference line
aftertouching the 30-level.
All things considered, the price decline is not as large as anticipated. After all, the RSI
dropped well below the 40-level. Still, it looks like the RSI has entered a descending
channel and the recent RSI advance is out-of-proportion with the rise in prices. The
RSI reaches the 62-level, while price is lower than on previous occasions. This is
another sign ofweakness.

• [)ely FOREX l-1.2709 -0.00)5 .oDS'l. 8-12709 ....1 2712 0-1 .2716 ti:1 .2722 L0"1.2689 C-12709 V-o
1 .3400
1 .3200
1 .3001
Cleated wih T.adeS'ation
Figure 2.40 Daily EURJUSD (continued from Figure 2.39).
The RSI reverses down from the 60-level. At this point, it is clear that a continuation of
the rally is excluded, as long as the RSI is unable to decisively rise above 65. In other
words, the RSI will have to break out ofits descending channel in order to avoid a push
into bearish territory. Given the weakness of the Euro, it is likely that the RSI will
reverse down when it reaches the upper boundary ofits descending channel, which will
be around 60 or 65, ifnot lower. This meansthatthe RSI may enterbearish territory on
its way down to the lower edge of its channel.
97

Walter 1. Baeyens
.Doiy FOOEX l-1 184D >D£lJ11 >D.o9'II. 8-1.2840 A-I.2843 0-1.2830 1i-1.2699 lo-l.2827 C-I 184D VO{)
Line N'
1 2<00
1 .2200
1 .2o:xl
I II1l)
, )
Cieall>d ....n T,odoStolion
Figure 2.41 Daily EURIUSD (continued from Figure 2.39 and Figure 2.40).
The RSI seems ready to break out ofthe RSI Squeeze on its wayto theupperboundary
ofits descending channel. Ifit breaks out ofthe channel at the arrow, it means that the
RSI is moving within its ascending channel. This charthas been completed with additional
references. The main one is the line through Point Q, which is the reference point for
the latest (DD+) signal, running parallel to the previous ascending channel.
By doing this, we have defined two possible scenarios. The RSI continues down within
its newly formed descending channel or the RSI continues moving up after the recent
(DD+) signal within the ascending channel, (which is parallel to but lower than the
previous one). We can also say that the recent rise in the RSI is unusually steep
because the normal angle of ascent for the RSI sub-channel is defined by Line N.
Ifa Line N' is drawn through Point Q, parallel to Line N, an impression ofthe normal
RSI movement can be obtained. We can expect the RSI to drop to Line N'. Here it
could reverse up in an attempt to break out ofthe descending channel. However, ifthe
break-out fails, a drop below Line N' will signal the start ofa modest correction down,
just like it did on three previous occasions.
98

PART XII
USE OF RSI (3)
Ifthe 14-period RSI picture becomes blurred or ifyou are doubting which RSI extremities
to use for (DD) reference points, take a step back and look at the larger picture by
switching to a 3-period RSI. The basics ofthe RSI interpretation are applicable here,
but the picture is much less detailed in the 3-period look-back RSI. That is why it is
such a great tool for a quick assessment of the market conditions and the RSI-Iogic
associated with it.
The RSI(3) is calculated with the usual RSI equation, but is based on three periods of
look-back data. The basic characteristics remain the same as the 14-period RSI, with
respect to the Disproportional Displacements, so (DD) signals similar to the ones that
we have studied in the RSI( 14), also form in the RSI(3). With what we know about the
general behavior and logic of the RSI, we should be able to detect some interesting
signals in the RSI(3) as well. These signals can be overlaid on the RSI(1 4) and will help
us define the correct channels in the RSI(14). If you want to spend minimum time
performing RSI analysis, take a quick look at the RSI(3) and apply some simple rules.
Andrew Cardwell proposed the use ofthe 3-period RSI to pinpoint buy and sell signals
withthe following reasoning:
1) The RSI(3) hits overbought conditions at the 80-level at a certain price.
2) A sell signal occurs when the RSI(3) hits the 80-level, with a lower
corresponding price.
If conditions become overbought at a lower price level than the previous overbought
condition, that is bearish. If the 3-period RSI becomes oversold around the 20-level,
while at a higher price than on the previous occasion, that is bullish.
While this sounds logical, it is difficultto determine which RSI levelsone should compare
with previous occurrences in practice. The 3-period RSI moves so quickly that it is
often difficult to find RSI extremities with identical RSI readings. As I mentioned
earlier, I also have some problems with the concept of"oversold and overbought" RSI
levels. Let's have a look at the correlation ofthe RSI(3) with price movements.
First, I want to provide a note about the RSI settings used in the RSI(3)charts. The line
displayed on the chart is the 3-period moving average ofthe 3-period RSI, notthe actual
indicator value. The 3-period moving average line ofthe 3-period RSI is much smoother
than the underlying RSI(3) line and provides a smooth, easy-to-use RSI picture.
Here are some basic rules for the daily RSI(3) charts: Bearish territory is roughly the
RSI zone from 0 to 80, while bullish territory is roughly from 20 to 1 00. As in the
RSI( 14), Disproportional Divergence in the 3-period RSI causes the formation of(DD)
signals. Ifyou see the RSI(3) make an out-of-proportion move, do not follow it; prices
will move to new extremes when it reverses. Look for (DD+) and (DD-) signals using
the reference points def
med earlier forthe RSI(l4) signalsandplotthe channels associated
99

Walter 1. Baeyens
with these signals. Note: The channel boundaries will not appear to be parallel lines at
times. This is not a problem, as (the most significant) lines that connect the (DD)
signals reference points in the RSI are all that is necessary.
Figure 2.42 Daily NDX with 3-period RSI
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This chart provides a good example ofwhat the RSI(3) can do. In this daily chart of
the NASDAQ l OO, we have a nice up-down-up cycle in the price chart. Let's discuss
the different points.
Point A: The RSI moves up from the 40-level, signaling strength. Bullish territory in
the daily RSI(3) is situated between the 20- and l OO-level, while bearish territory is
situated in the 0- to 80-zone. From PointA to Point I, the RSI(3) stays above 20 (as the
rally develops). From Point K to Point M, the market moves through a bearish phase,
and the RSI(3) reaches a value below 5 at Point K. From Point 0 to Point W, the
RSI(3) is back in bullish territory.
Point B: The RSI(3) rises above 90 as price rallies.
Point C: Just prior to this point, the RSI drops significantly while price hardly moves.
This is the Disproportional Divergence phenomenon that was observed in the l 4-period
RSI. As the RSI reverses up after the dip, price surges to a new high at Point C. The
RSI(3) value is well over 90.
Point D: The RSI(3) makes another out-of-proportion drop after Point C, while price
moves modestly lower. Again, as the RSI reverses up at Point D, it is well above the
100

20-level and price resumes the uptrend. The RSI drop between Point A and Point D
results in a (DD+) signal. Past Point D, the RSI struggles at the 70-level, which is a
sign ofweakness.
Point E: After the RSI fails to rise above 80, price corrects downward modestly and
the RSI drops to Point E, a new RSI low near the 20-level. There is a (DD+) along
Line A - D - E, connecting RSI lows that correspond with higher lows in price.
Point F: After the (DD+) signal at Point E, the RSI is propelled into bullish territory to
values well above 90. Price reaches a new high. The RSI drop from Point F takes the
RSI straight back to the 20-level, where it reverses up. The next RSI top, between
Point F and Point G, fails to reach the 80-level; a sign ofweakness.
Point G: This RSI low is in bearish territory. Price consolidates as the rally starts to
flatten out. There is a (DD+) signal between Point E and Point G, but only because
price at E and G are identical. Also, Point G is below the 20-level, which leaves some
doubt about the effect ofthis (DD+).
Point H: Disappointing action after the (DD+) signal at Point G. The Disproportional
Divergence is working the other way now. The RSI value rises to 70, but prices hardly
follow the up-move.
Point I: The series of RSI lows that occur prior to Point I are a (DD+), as they
correspond to higher lows in price. The Line G - I is the equivalent of the ChanneF
used in the RSI(1 4) analysis. This means that as long as the RSI manages to stay
above the Line G - I, we should see price rally to higher highs.
Point J: The rally fails. The RSI does not reach the 80-level; it reverses downward.
Price action is so weak that only a lower high is reached. In fact, the formation of a
(DD-) signal at Point J conflicts with the previous RSI peak.
Point K: As the RSI drops from Point J, it breaks below Line G-I, invalidating the
previous (DD+) entering bearish territory. Prices break below the consolidation support
line. After the topping action seen previously, the market enters a bearish phase.
Point L: The RSI is unable to rise over 80, remaining in bearish territory. The line at
Point L defines a (DD-) signal, as it connects higher tops in the RSI that correspond to
lower highs in price. Following this (DD-), prices fall to new lows.
Point M: The RSI is still in bearish territory below the 20-level. A positive divergence
is building. We know that this can lead to a trend reversal up, ifit succeeds in pushing
the RSI into bullish territory. The Line K-M is the lower boundary of an ascending
channel. If another (DD-) forms past Point M, the RSI will have to drop below this
Line K-M for the (DD-) to take full effect.
Points N and 0: Within the channel defined by the Line L and its (nearly) parallel Line
K-M, a (DD+) signal is formed at Points N-O. At Point 0, the RSI remains well above
20 and the rally resumes.
101

Walter 1. Baeyens
Points P and U: All ofthe RSI peaks in this period reach the 90-level with ease. The
market is in bullish territory.
Points O-R-T-V: This line defines the lower boundary ofan ascending channel, which
is well above the 20-level. Within this channel, we have a series of(DD+) signals at
Point N and Point 0, at Point Q-R and at Point S-T. This corresponds with what we
learned about the RSI(l4) in an uptrend and the importance ofits ChanneF. The rally
continues as long as the RSI stays within its ascending channel.
Point W: Oops! The RSI fails to reach the 70-level, although price reaches a higher
high. A strong negative divergence is building here. The question now is whether ornot
the RSI is going to break below the Line O-R-T-y' If it does, we can expect it to
reverse up before reaching the 20-level, remaining in bullish territory. It will also be
interesting to see whether or not the RSI breaks below the extended Line K-M, as this
could be considered the lower boundary of an ascending ChanneF, with the upper
boundary defined by Line J-P.
If the RSI reverses up from this hypothetical Point X, we will see the formation of a
(DD+) in relation to one ofthe previous RSI lows (possibly Point V or even Point 0).
However, ifthe RSI drop is deep, the following rebound may result in a (DD-) signal.
This would mean a possible repeat ofthe scenario at Point J.
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102

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Figures 2.43 and 2.44 offer a good example of how the 3-period and 14-period RSI
pictures, covering the same time period, can be correlated. Both are daily charts ofthe
Semi-Conductor Index (SOX), covering about 1 8 months ofdata. The picture in the 3-
period RSI chart is simple. From November 2005 to February 2006, the RSI is above
20 and forms (DD+) signals within its ascending channel.
In March 2006, following the (DD+) signal, the RSI breaks down from its ChanneF,
invalidating the (DD+) signal drop below the 20-level.
The RSI rebound in March andApril 2006 stalls atthe 80-level in bearish territory, while
the RSI tops define a (DD-) signal, followed by a steep price drop in May 2006.
In June and July 2006, a positive divergence starts to define the lower boundary ofan
ascending ChanneF. In mid-August 2006, the RSI peaks at the 90-level in bullish
territory and the following RSI decline results in the formation of a string of (DD+)
signals. This illustrates a reversal signal within the ascending ChanneF, which was
defined by the (DD-) signal at its start. The positive divergence pushed the RSI into
bullish territory. Also note that the most recent RSI low in late October 2006 reached
the 20-level. The RSI is now dropping back from the 60-level. Will it manage to stay
above 20 or will it break below the ChanneF bottom?
Figures 2.43 and 2.44 illustrate the correlation between the 3-period RSI (Figure 2.43)
and the 14-period RSI (Figure 2.44). Note that the RSI(3) gives an early indication of
the start ofthe positive divergence in October 2005 and in June 2006. The RSI(3) drop
in March 2006 points to possible trouble ahead, as it follows an initial (DD-) signal and
goes well below the 20-level, while the RSI(l 4) picture shows the RSI merely leveling
offaround the 40-level.
103

Walter J. Baeyens
The RSI(14) chart provides a better picture ofthe larger degree ChanneP, (a descending
channel with its upper boundary around the 60-level). Ifthe most recent (DD+) signal
is to take effect, the 14-period RSI needs to break out ofthis descending channel. This
meansthat the RSI must staywithinthe new ascending channel def
medbythe consecutive
(DD-) reference points in February through May of2006. Within the framework ofthis
potential new ascending channel, the recent (DD+) signal can be interpreted as a
"reversal" signal because this channel, at its origin, was defined by a (DD-) signal. In
the 3-period RSI, this means that the RSI should not break below the ChanneF lower
boundary, situated near the 20-level. Further indecision will also cause the 14-period
RSI to zero-in on the 50-level.
PART XIII
PRACTICE
Let's work through some examples and apply what we have learned about the Relative
Strength Index so far.
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Figure 2.45 Weekly Dow Jones Utilities Index
Up to Point A, the RSI moves within a descending channel, reaching bearish territory,
while price drops considerably. The ascending channel that starts at PointA is defined
104

by a (DD-) signal at its upper boundary. In Quarter 2 of2004, the first (DD+) signal
forms in this channel, well above the 40-level. This heralds the beginning of a bull
market as the RSI stays above the lower boundary ofits ascending channel. The RSI
value rises to 85, which is quite impressive in this larger weekly time frame.
Past the RSI peak, we notice the formation of a negative Price/RSI divergence as the
market moves into 2005. As is so often the case, this divergence, at the highs of the
RSI, is accompanied by a (DD+) signal forming at the RSI lows. The negative
divergence causes the RSI to violate the channel bottom, which is an early indication
that a new descending channel may be forming. But the indicator is well inside bullish
territory and when the (DD+) takes effect, price rallies to a higher high while the RSI
hitsthe 85-level again. After hitting this extreme 85-level a second time, the RSI drops
below its ascending channel at Point X. As discussed, this does not imply the rally is
over, as the RSI remains high in bullish territory. It does indicate that the rally is losing
steam andthe RSI is likely to form a (DD+) signal with a less ambitious price target. In
other words, the slope ofthe rally is becoming less steep.
Past Point X, we see a steep out-of-proportion drop in the RSI. We know we should
not follow the RSI here, as a reversal up will see prices move higher. At Point B, the
RSI finally reverses up around the 50-level, forming a new (DD+), effectively defining
the lower boundary ofa new descending channel. Through Point B, we can plot a line
parallel to the Line A-X, which we can use as reference for the validity of this new
(DD+) signal. For this (DD+) to take full effect, the RSI needs to stay above this line.
This should confirm the start ofa new ascending channel, parallel to but lower than the
previous channel defined by the Line A-X.
We also know whatwouldhappen ifthe RSI were to drop below this line through Point
B. The most recent (DD+) signal would be invalid and the RSI would not escape from
its descending channel; it should, in order to avoid ending up in bearish territory. Past
Point B, the RSI does not succeed in rising above 60 and drops below the potential
ascending channel reference line, indicating that the RSI is continuing its course in the
descending channel.
The RSI reverses up at Point C, bouncing off the lower boundary of its descending
channel, as anticipated. Point C is situated at the 40-level, well within bullish territory.
Again, we can draw a line through Point C parallel to the previous Channel Line A-X
and the potential channel line through Point B. This time the RSI stays well above the
reference line, climbing steeply within a sub-channel (not shown), breaking above the
60-level as price reaches a new high.
By the end ofthis chart, the RSI is in bullish territory and the question is: Will the RSI
break out from its descending channel or is there going to be another cycle down? The
bull market is not in danger as long as the RSI remains in its ascending channel. Ifthe
RSI reverses down now, we can expect it to reverse up from the reference line through
Point C, forming a new (DD+) signal at the 50-level in the process. This scenario
means that the RSI is traveling in its ascending channel, possibly rising to the 85-level
again, whileprices reach higher highs.
105

WalterJ. Baeyens
The lines in the price chart are support lines that correspond to the (DD+) reference
points in the RSI. Please note that the support line corresponding to the (DD+) signal at
Point C is less steep than the support line at Point B.
In this RSI picture, a line (through Point A and Point C) is missing - one that would
define the lowerboundary ofthe larger degree ChanneP, which is an ascending ChanneP.
In this particular channel, we see the formation of a (DD+) signal at Point C. This
larger picture is clearly bullish, as long as the RSI stays above the imaginary Line A-C.
A line could be drawn parallel to Line A-C, (to see how it fits the picture at the upper
boundary ofthis ChanneP).
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Figure 2.46 Weekly DJU
Within this larger degree ascending ChanneP, the Channel A-X (up) and the Channel
B-C (down) can be interpreted as an up-down RSI cycle. In this scenario, the down
cycle, including the negative PricelRSI divergence, has not damaged the uptrend.
Figure 2.46 shows a possible interpretation of the bigger picture. There is a giant
(DD+) signal, (the lower edge ofChanneF), within its larger ascending ChanneP. The
lower boundary ofthis ChanneP is the validity reference line for the giant (DD+).
106

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The 9-period simple moving average and 45-period exponential moving average are
added in the RSI chart. The crossing up of these moving averages marks the points
where the uptrend resumes. I find the moving averages useful in the daily and weekly
RSI charts, as their crossing up or down often confirms and coincides with relevant
reference points.
In this example, the circled moving average crossing pointmarks the best RSI extremity
to define the (DD+). At the reversal up of the RSI in mid-April 2005, there were
several possibilities to draw the (DD+) line through various RSI extremities. In such
cases, it is recommended to take the RSI reference point on or nearest the crossing
point ofthe moving averages. Failing this, a look at the 3-period RSI chart for the same
time frame could provide clarity as to which RSI extremities qualify best for the (DD+).
We will need to see the RSI rise into the next slice as the rally continues. In this case,
it is clear that the (DD+) reference line is a good choice because its parallel line proves
to be a good reference line for a series of (DD+) signals from June through October
2005. Also note that the (DD+) formed on this line by the end of June, as the RSI
reversed up well within bullish territory, is a FAST (DD+).
In theprice chart, the (DD+) line serves as a support line andhelps checkthe validity of
the (DD+) signal. In this case, price breaks below this support line in May 2005, but this
107

did not invalidate the (00+) signal because the RSI remained above its ChanneF
reference line, which runs parallel to a previous channel (not shown).
In October 2005, the RSI drops below its ChanneF and below the 40-level after a two
month negative divergence. As the RSI reaches the underside ofits previous ascending
channel, it is clear that there is a risk ofa (00-) signal forming as the RSI reaches 50,
while price has not exceeded 1 000, the Lighthouse level ofa potential (00-).

CHAPTER THREE
RSI TIME FRAME CORRELATION

PART I
INTRODUCTION
So far, we have learned how to detect, interpret and check the validity of(DD) signals.
We have studied the "RSI logic" as it moves inside its multiple channels, which allows
us to draw conclusions about the state ofthe market in one particular time frame. Now,
it is time to examine the correlation between different RSI pictures taken from various
time frames.
As we have discussed, the RSI picture changes drastically as you zoom in on it by
switching to smaller time frames. In fact, there are thousands ofdifferent RSI pictures
and each one represents the same price action. Imagine using a computerprogram that
would allow you to display a weekly chart ofprice and the RSI, and allow you to zoom
in on the most recent price action by reducing the chart's time frame by I -minute
increments. Each picture would be slightly different than the previous one and the RSI
wouldcometo life, snaking in tighter patterns, appearing animated.
Each ofthe many RSI pictures is a true representation ofprice action, after it has been
through the RSI equation. Needless to say, it would be impossible to examine all ofthe
pictures. We will choose a few that will help us understand the price reality of the
moment. I propose that we use the weekly-daily-hourly combination for longer-term
analysis and the daily-hourly-1 5 minute combination for the shorter-term analysis. The
choice oftime frames is arbitrary; any time frame that provides a clear picture ofthe
RSI channels is wortb close examination. I bave experimented with Fibonacci-related
time frames, boping to find an interesting correlation in their RSI pictures, but the results
do not indicate that any particular set oftime frames is better than another.
What makes the hourly RSI pictures so different from the daily chart? First, there is the
difference in the look-back period, wbich is 14 days in the daily time frame and 14
hours in the hourly time frame. Also, the RSI is calculated based on closing prices for
each ofthe 1 4 periods. Imagine tbe Dow Index is in negative territory all day, before a
rally in the last hour, ensuring that tbe closing is unchanged. In the daily RSI chart, the
result is a short, one-day, nearly horizontal line; the hourly RSI shows five periods
closing in the red and one period closing in the green.

Walter 1. Baeyens
The RSI reverses upward at some point near the close ofthe session. This reversal up
may have been a (DD+) in the hourly chart, while in the daily chart, the only bullish
indication may be the long shadow, or "wick" in the candlestick, representing the price
action ofthat day. Still, both the daily and hourly RSI chart, however different, tell us
something fundamental about the recent price action. In the I 5-minute chart, a positive
divergence may have pushed the RSI into bullish territory early in the session, and a
(DD+) signal may have developed toward the end ofthe trading day. All of these RSI
pictures are different (but true) statements about the market action.
In this respect, Time Frame Correlation (TFC) adds an extra dimension to the RSI
analysis because it canbe used to examine and correlate multiple true statements about
the same price reality. Using our knowledge of the underlying RSI logic, it must be
possible for us to find a link between the RSI pictures in the various time frames. This
should improve our ability to determine plausible future scenarios.
It is impossible to consider every RSI combination that may result from various RSI
pictures in multiple time frames. But once the basics are understood, you will be able to
find a meaningful correlation. In my opinion, what was absent from the RSI rules as
defined by Welles Wilder and Andrew Cardwell is the dimension of Time Frame
Correlation.
Any statement relating to a particular RSI situation and its consequences should at least
define the time frame from which the RSI study is taken. Ifthe Time Frame Correlation
element is missing, any statement about the interpretation ofan RSI pattern becomes
meaningless, because it may be contradicted by the RSI picture from a different time
frame. We will study how to interpret contradictory RSI signals when they occur in the
same time frame and in different time frames.
There is no single, unique time frame that will produce the perfect RSI picture and
predict what will happen in the market. The time frame that produces a clear picture of
the RSI channels is a relevant timef
rame. This means that the actions of the traders
in that particular time frame determine the direction ofthe market.
John Hayden calls this "the force," in an attempt to add some degree ofspecification to
the general RSI rules as defined by Andrew Cardwell. In other words, analysts should
attempt to determine which time frame is "in charge" and go with the signals originating
from that time frame in orderto avoid trading against the force. Unfortunately, Hayden's
method for isolating the market-leading time frame is very vague and is neither based
on, nor applicable to the RSI picture. My conclusion is that 1 ) the analysis ofthree RSI
pictures results in a more consistent determination about the market's direction and 2)
any time frame that produces a clear RSI channel picture is relevant.
112

PART II
BASICS OF TIME FRAME CORRELATION
At any time, market direction is determined by the combined actions ofall participants
with their different objectives, intentions and strategies. Sometimes the short-term day
traders control the market, then the swing-traders may step in, and some time later, they
all may be swept away by a wave oforders originating from long-term investors. This
means that decisions based on signals from one particular time frame will only get you
so far.
Here, I return to the concept oftrend, and the questions: "Is there only one real trend?"
Earlier, we came to the conclusion that the concepts of oversold/overbought market
conditions have no absolute meaning. The trend should be defined in the same way
depending upon the time frame from which it is taken. It is possible to have an uptrend
in the hourly chart and a downtrend in the daily chart, while the weekly chart shows an
uptrend and the monthly chart shows a downtrend.
It is important to understand the concept oftrend magnitude. Trends originating from
the longer-term traders, who base their decisions on weekly or monthly charts, are ofa
different magnitude than trends originating from short-term traders who base their
decisions on hourly charts. These traders have different objectives, different portfolios
and very different stop-loss limits.
In the RSI, this concept is reflected in price targets; a (DD+) signal taken from the
weekly chart will be much higher than the price targets taken from an hourly chart. A
trend of the weekly magnitude is much more powerful than a trend of the hourly
magnitude. Ifthe latter is referred to as a "wave," then the former should be called the
"tide." When price approaches its target in the weekly chart [after a (DD+)], there will
be a series of(DD+) signals in the daily charts that reach their consecutive, but more
modest, price targets.
There must be a series of successful (DD+) signals in the hourly chart if the weekly
target is ever to be reached. This is the basis ofTime Frame Correlation: Determine
what occurs in the smaller time frames that could affect the signals in the larger time
frames. Or, find out whether the larger time frame signals are working for or against
you.
Here is another way of looking at the concept of Time Frame Correlation: When an
uptrend in the daily chart comes to an end, a sizeable price decline, followed by a
shallow retracement up, will cause the formation ofthe very first (DD-), thus telling us
that the trend has changed. As a result, our portfolio takes a hit as prices initially
decline. Whynotcheckthehourly time frame for (DD-) signals? This smaller specimen
of the (DD-) requires a less severe formation of the price decline-and-rebound. Any
price decline, big or small, starts with a modest price slide in the smaller time frames,
which eventually spills over into the largertime frames.
113

Walter 1. Baeyens
One should also look for conflicting signals in the smaller time frames. However, in the
very small time frames, you will find that the usual market "background noise" causes
a string of contradictory signals that lead nowhere. I recommend using the daily
hourly- l 5 minute combination for short-term analyses, but the RSI rules applyjust as
well to 5-minute and 3-minute charts. Please note that this means that in Time Frame
Correlation, we will be confrontedwith situationswhere contradictory signals aredetected
in the various time frames. How do we correlate these signals?
Recall the earlier illustration ofthe skater's half-pipe. Figure 3 . 1 provides a graphic
representation ofTime Frame Correlation logic involving two different time frames (the
daily and hourly). The larger daily half-pipe is in the bullish mode, showing readings
ranging from 40 to 80. However, the smaller hourly half-pipe is tilted the other way
with RSI readings ranging from 20 to 60. Since this time frame is in bearish territory, it
may cause the larger daily half-pipe to shift its balance to the bearish side.
Figure 3.1
HOURLY
BEARS DAILY BULLS
1 14

PART III
FAILURE OF (DD) SIGNALS
What is the significance of a (DD) signal's failure to reach its price target? Andrew
Cardwell believes that price target failures, even ifthe target is only missed by a few
points, arejust as relevant as the signals themselves, because they indicate a weakening
or reversing trend. In my experience, the negative impact of (DD) signal failures
should not be overestimated. Remember, in order for a (DD+) to be formed, a shallow
price retracement down is required.
One could argue that in an uptrend, the absence of (DD+) signals (other than those
caused bynegative divergence), is a sign ofstrength becausethere is a lack ofdownward
retracements. The shallow retracement in an uptrend, [causing the formation of a
(DD+) signal in the daily time frame] may be deep enough to cause the failure of a
(DD+) in the hourly time frame. It may even cause a (DD-) in the hourly time frame.
A (DD) failure in the weekly time frame is more significant than a (DD) failure in the
hourly time frame, because the down retracement required for the formation ofa new
(DD+) in the weekly time frame is large enough to actually hurt your portfolio.
The time allotted for a (DD) signal to hit its price target is not clear. After a (DD+), it
is possible for prices to go sideways for some time, without reaching the projected price
target. When is it time to consider this (DD+) signal as a failure? When a new (DD+)
is formed? Is the new (DD+) bound to fail as well? If not, then why was the alleged
failure ofthe previous (DD+) so important?
Price targets calculated from diverse (DD) reference points are best viewed as indicators
of the direction and strength of the forces acting on the trend. At any time, as we
browse through the RSI charts in the different time frames ofone particular equity, we
will find dozens of co-existing (DD) signals. Many of the (DD) signals will be
contradictory and will inevitably fail to reach their targets.
115

Walter J. Baeyens
Figure 3.2.
c
A' 8'
(00+)
(00+)
Figure 3.2 depicts an uptrend in price and its corresponding RSI chart. What can we
say about the failing (DD+) signal at Point C? [Remember, in the context of this
discussion, "failing" means that the calculated price target for that (DD+) was not
reached]. There is an initial (DD+) in reference to Points W-X. After price reaches
the projected target at Point B, a second (DD+) forms in reference to Points X-Y. The
price support line for this (DD+) shows that the uptrend is becoming steeper, but at
Point C, price reverses downward before reaching its target. At what point can we say
that this (DD+) failed?
The term "failure" is not appropriate to describe this RSI behavior, because it implies
that something irreversible has happened. This is not the case. At Point Z, price drops
below the Lighthouse level Y, so there is no (DD+) at Points Y-Z, because Price Z is
lower than Price Y. In the RSI chart, we see that the RSI reverses up at Point Z', from
the lower boundary ofits descending channel, where a series of(DD+) had been building.
There can be no (DD+) at Points Y'-Z' but what about Points X'-Z' or even W'-Z'?
Price Z is higher than Prices X and W, while the RSI is lower at Point Z' than at Points
W' and X'. So, while no (DD+) exists at Points Y'-Z', we could consider a (DD+) to
be valid at Points W'-Z' .
116

RSI: Logic. Signals & TIme Frame Correlation
In the related Fibonacci method, when a price retracement down covers more than
1 00% ofthe last price advance, what do we look for next? This is the case at Point Z,
in relation to the price rise from Point Y to C. Looking at the broader picture, we can
measure the ratio of the latest price decline against the larger price advance. In this
case, the price decline from Point C to Z is only about 50% ofthe price advance from
Point W to C. In this respect, the price decline into Point Z is still shallow and the
(DD+) in reference to Points W' and Z' is still valid.
We need to check the level where the RSI reverses at Point Z'. If it is well below the
40-level, we know that a (DD-) signal could form at Point D. The odd thing about the
(DD+) at Points W' and Z' is that its price target is higher than the missed target at
Point C, because the price difference between Point W and Point Z is much larger than
the price change from Point X to Y. As a result, the failure ofthe (DD+) signal at Point
C did not damage the uptrend. It was a preamble to the formation ofanother (DD+) in
the broader picture.
This illustration points to a flaw in the Fibonacci method. Ifyou take a step back each
time a price retracement exceeds 1 00% of the previous price change, when do you
decide to stop regressing and consider the trend to have reversed? Obviously, as was
the case for the old RSI rules, the missing element is the extra dimension added by Time
Frame Correlation. In the Fibonacci method, this can be achieved by using clusters of
Fibonacci reference lines, calculated from a multitude ofprice reference points in various
time frames.
In our example, the failure ofthe (DD+) signal is not significant. However, because of
it, the RSI stays within its descending channel. We know that this will eventually push
the RSI into bearish territory, and it does, at Point D'. The RSI fails to break out and
drops deeper into bearish territory. In price, this results in a Head & Shoulder formation.
Also, since Price D is lower than Price C, we may have the first (DD-) at Point D' (not
shown). This would be more significant than the failure ofthe (DD+) at Point C. The
alternative scenario is that the RSI breaks out at Point D', while price stays above the
extended support line W-Z, validating the (DD+) signal at Points W'-Z'.
In this scenario, the formation ofa (DD-) signal and the further decline ofthe RSI could
have been avoidedand prices could have rallied to a new high, possibly to the projected
target ofthe (DD+) at Points W'-Z'. This example clarifies why I do not believe that
(DD) failures are very significant. I believe that the appearance ofa conflicting (DD)
signal is more important, as is the nature ofthe most recent signal in the next larger
time frame.
117

Walter J. Baeyens
Figure 3.3
A
1
�. .
.
. . . . . .
. . '
. . '
. . '
. "
. '
c
" .
, . '
, .. .. .. � ...
... ..
��::::------------------------- ----------------- -------------
4
... ...
... ...
... ...
... ... ... ...
OAILY (00+)
" .
" ,
,
,
,... ...
... ...
X '
,
,
,
Figure 3.3 illustrates the previous point. In this hourly price chart (the RSI chart is not
shown), suppose we have a (DD+) along Line I , but at Point B, price declines and
drops below the (DD+) support line without hitting the (DD+) price target. This price
decline results in a new, less ambitious (DD+) signal along Line 3. This (DD+) signal
fails as price does not exceed price level B.
In order to form a (DD+) in the daily chart, the price decline into Point D is required.
Prices rally to their daily (DD+) price target, exceeding price level A. In this example,
the potential contradictory signal in the hourly RSI is more important than the failure of
the (DD+) signals to reach their targets. The price decline to Point D and subsequent
rebound to Point E may have caused the formation ofa (DD-) in the hourly RSI chart.
If this takes effect, it may cause price to break below the daily (DD+) support line at
PointX.
One can use the same reasoning for the failure ofthe hourly (DD+) at Point C. At this
point, we can look at the I S-minute chart, and we may find that the price decline from
Point B and the shallow rebound into Point C causes a (DD-). This is the object ofthe
Time Frame Correlation study.
A last glance at Figure 3.3: Did the initial hourly (DD+) along Line I really fail? After
all, the larger daily (DD+) may push price well above its projected price target. In my
experience, (DD) price targets are best viewed not as make-or-break reference levels.
Rather, one should view them as vectors that may act with or against the larger trend,
which in turn is the result of the combined actions of many vectors in various time
frames. If we detect a vector acting against the next larger vector, it needs to be
118

monitored, in order to determine which one will prevail. The effects of the smaller
vector may spill over into the larger time frames, much like the imaginary hourly
(DD-) (at Points C-E in the previous example) may prevent the daily (DD+) from
taking effect.
- Deity NASOAQ l-53.13 +0 17 +O.32'l. B-52.92 A..s4.10 0-53,08 H-54.D2 l0-52.S1 C..
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fiUJ
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Figure 3.4 Daily LRCX Chart
This chart more clearly exemplifies our discussion. There is a (DD+) signal at Point C,
well above 40. This (DD+) signal remains valid as long as the RSI stays above the Line
A-C-D. However, the arrow marks the point where a (DD-) appeared in the hourly
chart after the hourly (DD+) failed to reach its price target.
1 19

Walter 1. Baeyens
ReX - 60 mi1 NASDAQ l·52.� -0.17 -0.32% B-52.03 A.53.90 0.52.79 fi.S3.80 lo>5201 C.s2.� V.2291657
�::==::�=��CH�A;NN;E;l,======�ilL��=i'0'OO
9/14 9/18 9J2O 9J25 9/26 10m lG.05 1 0110 1 0113 10117 1 0120 1 0125 1 0.00 11A)1 1 1 .0; 11.(19 1 1 113 11116 11121 11127 11130 1204 lW7 12Jf2 12115
c....ed wih TrodeS!aIion
Figure 3.5. Hourly LRCX.
Ifthis hourly (DD-) invalidates the daily (DD+), the daily RSI value will drop and (most
likely) build another (DD+) at a lower level. Any way you look at it, ifthis drop causes
another (DD-) signal to form in the hourly time frame, this scenario may be repeated.
Sooner or later, the hourly (DD-) must be invalidated by the daily (DD+) ifthe rally is to
continue. Ifthis fails, a series ofhourly (DD-) signals will eventually cause the formation
ofa (DD-) in the daily time frame. The (DD+) signal at Point C will not reach its price
target unless it invalidates the hourly (DD-), but new (DD+) signals may form untiI the
Lighthouse price level at $45 is broken.
120

PART IV
TIME FRAME CORRELATION: ZOOMING IN AND ZOOMING OUT
By referring to Figures 3.6 and 3.7, we can discuss Time Frame Correlation from
different viewpoints:
1. The short-term trader studying the I 5-minute chart wonders how far the
price retracement down would carry ifthe RSI breaks downward from its
ascending channel.
2. The long-term trader studying the daily chart looks for early signs and
wonders whether the RSI will break down from its ascending channel,
offering an opportunity to sell.
Let's examine the perspective ofthe short-term trader. She is aware that the RSI in the
I 5-minute chart did not succeed in breaking above 70. This resulted in an RSI Squeeze,
causing the RSI to drop below its ascending channel as expected. This signaled the
start of a price retracement downward. A moderate rebound in price, following the
initial decline, saw the RSI pop up to form a (00-) sell signal at Points y-z. Our trader
now wonders what to expect ifthe RSI continues its decline past Point x.
She switches her analysis to the 60-minute time frame and finds that the RSI is
approaching the lower boundary ofits ascending channel. Additionally, after the (00+)
signal at Points A-B, the RSI is unable to break out above the Line A'-B', indicating
market weakness. It is not surprising that the RSI is unable to rise above 70 in the 1 5-
minute chart. Our trader anticipates a price retracement in the 60-minute magnitude as
it becomes clear that the RSI drop in the 1 5-minute chart is going to trigger the RSI to
cascade downward in the 60-minute time frame.
Furthermore, she finds similar signs ofweakness, in the daily chart, with the RSI unable
to rise into the next up-segment of the chart. This means that the (00+) signal that
formed in the daily chart at Points A-B is failing. Ifthe RSI breaks below its channel
support line at Point x, this would signal the start ofa price correction down in the daily
magnitude.
Our trader decides to short the market whenever the RSI falls below Point x in the 1 5-
minute chart, anticipating that this will trigger an RSI break-down in the 60-minute and
daily time frames. She considers that this scenario would be invalidated ifthe RSI in
the I 5-minute chart were to reverse back up to break out from its descending channel
and rise above the 70-level. In such a case, the RSI in the larger time frames should
bounce up from its channel support line.
She also considers that the price projection target calculated from the (00-) signal in
the 1 5-minute chart will probably be exceeded, if the RSI values from larger time
121

Walter 1. Baeyens
frames cascade lower as anticipated. Figure 3.7 shows a possible follow-on scenario.
The I 5-minute RSI has declined further within its descending channel, forming new
(DD-) signals on the way down. In the 60-minute chart, the RSI has broken below its
channel, forming a (DD-) signal with a projected price target far below the original
target in the 1 5-minute chart. The dailychartshows the RSI breaking below its ascending
channel, marking the start ofa price retracement down ofthe daily magnitude.
The longer-term trader, finding that the daily RSI is approaching the lower boundary of
its channel, would like an early indication ofthe RSI breaking downward. He turns to
the hourly and 1 5-minute charts, checking to see whether any contrary signals that the
larger trend is unable to override have appeared.
Let's begin with an uptrend: The scenario to the start ofthe price decline in the daily
time frame is the RSI weakness and, in the 1 5- minute time frame, the formation ofan
initial (DD-). Let's examine how to interpret identical and conflicting signals in various
time frames.
122

Figure 3.6 RSI(14) 15 Min.
RSI(14) 60 Min.
RSI(14) Daily
123

Walter 1. Baeyens
Figure 3.7 RSI(14) 15 Min.
RSI(14) 60 Min.
RSI(14) Daily
124

PART V
IDENTICAL SIGNALS IN DIFFERENT TIME FRAMES
The occurrence of coinciding identical signals in the different time frames is easy to
recognize, as signals in various time frames align and reinforce each other. An uptrend
will be characterized by a series of(DD+) signals within an ascending RSI ChanneF.
As long as this picture exists in the weekly, daily and hourly time frames, the uptrend
will be safe.
When these conditions exist, the price target calculated from the (DD+) signal in the
weekly chart will be the most ambitious. In the daily time frame, each successive
(DD+) signal will have a more modest price target, but as time passes, these targets
add up to the greater weekly price target. The same goes for the hourly stream of
(DD+) signals and their respective price targets. We can use an improvised vector
representation to help us visualize how the trend force is acting upon price in one time
frame picture, and how this could be represented in the triple time frame picture.
Let's say that the direction (angle) ofan uptrend vector coincides with 1 ) the resultant
of the angle of the price support line for the (DD+) signal and 2) the change in price
required to hit the price target for thatparticular (DD+). A (DD+) is represented by a
strong trend vector up, with an ambitious price target and a steep price support line, as
shown in Figure 3.8.
125

Walter J. Baeyens
Figure 3.8
_ _ _
-----T�rget 1 - _ .. -
Target 2
RSI(14)
As the RSI reverses up at Point a, forming a (DD+) signal, the associated Price Target
I can be calculated, [which, in the price chart, is situated on the line parallel to the
(DD+) support line]. The vector ending at Target 1 symbolizes the imaginary force
pulling prices higher. Because the price target is not reached and the (DD+) 1 is
invalidated, the RSI drops to Point b, where it reverses upward again. At Point b, a
second (DD+) is formed, but this time, the resulting support line in price is less steep
and the price target is less ambitious than in the previous (DD+).
The trend vector ending with Target 2 symbolizes the force pulling on price,and we see
that this force is reduced in comparison to the force resulting from the first (DD+)
signal. As Price Target 2 is not reached and the (DD+) signal is invalidated, prices
correct downward in such a way that the shallow rebound into Point c causes the
formation ofa first (DD-). Again, in the price chart, the vector for this (DD-) signal can
be drawn based on the angle of the (DD-) resistance line and the calculated price
target. The result is the trend vector ending at Target 3, which points downward,
symbolizing the force pulling prices downward.
Figure 3.8 demonstrates a weakening uptrend followed by a trend reversal down in this
time frame. We also know that ifthis scenario unfolds in the hourly charts, the larger
magnitude price targets in the daily and weekly uptrend will never be reached until a
reversal up in the hourly time frameoccurs. Now, ifwe return to the vectorrepresentation
of (DD+) signals and plot those in an imaginary trend-vector chart for the three time
frames, we end up with something like Figure 3.9.
126

Figure 3.9 Trend VECTORS
H1 D1 W1
W2
DOWN 3 W3
D3
H3
The vectors ofthe hourly time frame are marked H I , H2 and H3. The vectors of the
daily time frames are labeled D, and the vectors for the weekly time frame are labeled
W. It is clear that the H-vectors are smaller than the D-vectors, because they have
smaller (DD) price targets resulting from the market of the hourly charts. The W
vectors are the largest because they are the result of giant (DD) signals in the weekly
charts.
Situation I is simple. All three vectors H I , D I and W I pull in the upward direction.
Vector H I acts on vector D I and both act on W I . There is a strong uptrend with no
bearish elements present. Then, there is a change in the hourly vector H Ib, which turns
negative. Ifvector H Ib continues to pull on vector DI , it will weaken its up-force and
if this condition persists, will cause the daily vector to turn negative. This results in
Situation2.
Situation 2 is more complicated. The continuous down-force exerted by the hourly
vector H2 has caused the daily D2 vector to turn neutral and the weekly vector W2
begins to feel the downward pressure. Overall, the uptrend of the markets starts to
show weakness.
Situation 3 shows all three vectors pointing downward. The hourly time frame keeps
generating (DD-) signals andthe H3 vector still points down. In our imaginary scenario,
this has caused a (DD-) signal in the daily time frame, resulting in the D3 vector pointing
down as well. The persisting bearish sentiment that has generated a series of (DD-)
signals in the hourly time frame and a (DD-) signal in thedailytime frame now takes its
127

Walter J. Baeyens
toll in the weekly charts as well. Vector W3 points downward with a first (DD-) signal
forming in the weekly time frame. The down-force at this point is still moderate, but if
all vectors continue to point downward, things will get worse. We may get another
(DD-) in the weekly time frame with a sharply lower price target, as the daily and
weekly vectors rotate clockwise, pointing deeper into the downtrend zone.
The start ofa market recovery becomes visible ifthe first (DD+) signal appears in the
hourly RSI chart causing the H-vector to tum up. The price moves up and down
required for a (DD+) to form are the smallest in the hourly time frame. A trend reversal
up is not possible without (DD+) signals forming first in the hourly charts. Ifthe (DD+)
signals keepmakingtheir appearance, eventually pointingto increasingly ambitious price
targets, this series ofprice rallies will eventually add up to a sufficient total price increase
and cause a (DD+) in the daily time frame. At that point, we would see the D-vector
tum up as well, adding to the up-force acting on the W-vector, eventually pulling it into
the uptrend zone.
The vector analogy is not a mathematically correct model. It would certainly be
interesting to build a model thatconstantly calculates (DD) price targets in multiple time
frames, while displaying the result in a single up-down vectorofvarying length. It isjust
an illustration ofhow to visualize the way identical or opposite (DD) signals affect the
underlying trend.
When (DD) price targets are not reached, it does not mean that the trend in a time
frame is about to reverse. As we have seen, it could indicate that the trend is flattening,
as new (DD) signals are forming with smaller price targets. After all, for a (DD+) to
form in the daily charts, a shallow price retracement is necessary. But a shallow price
retracement in the daily chart could be a substantial enough retracement in the hourly
time frame to cause a (DD-) to form. This means that a (DD-) signal in the hourly
charts, hitting its down price target, could very well be followed by a rally ofthe daily
variety, simply because this price decline and rebound caused a (DD+) signal in the
daily chart.
It is more important to check the direction of all three vectors, rather than to expect
each (DD) signal to hit its price target and interpretthe failure to do so as an immediate
threat to the prevailing trend. Still, this brings us back to the point that it is important to
look at the market activity in various time frames. Apotentialtrendreversal will become
visible first in the smaller time frames, when the smallest vector starts to act against the
larger ones. The same principle applies to the combination ofdaily-hourly- 1 5-minute
time frames, or any othertime frame ofthe same orderthatproduces clear RSI channels.
Important Note: Whenever I label a (DD) as having "f
ailed " it does not mean
that prices have not reached the projected (DD) target, but rather that either the
RSIf
ailed to escape f
rom its channel when it was requiredf
or the (
DD) signal to
take e
ff
ect or that the RSI violated the signal validity ref
erence lines.
128

PART VI
CONFLICTING SIGNALS IN THE SAME TIME FRAME
Before examining the interpretation ofopposing signals in different time frames, let's
see what we can logicallysay about opposing signals occurring in the same time frame.
Our understanding of how (DD) signals are formed and eventually invalidated will
guide us to the correct interpretation.
Figure 3.10
Figure 3.1 0 shows two conflicting (DD) signals. First, there is a (DD+) signal that
forms along the lower boundary of the descending RSI channel and there is a (DD-)
signal that forms inthe descending channel. This picture looks familiar. The descending
channel tells us something important because it leads to bearish territory. As we have
seen earlier, a descending channel, at its beginning, is defined by (DD+) signal reference
points. Unless the RSI escapes from this channel, it will end up in bearish territory. It
would be logical to assume that there was a (DD+) signal prior to Point c as well, but
we cannot tell from this chart.
The price decline leading to the formation ofthe (DD+) signal at Point d is quite deep,
erasing most ofthe gains madeduringtherally. Still, this RSI behavior is not uncommon;
it reverses up from the lower boundary of the channel, [which was probably already
anchored on earlier (DD+) reference points]. The fact that a (DD-) signal formed tells
us that the RSI must have entered bearish territory, where the disproportional moves of
129

Walter J. Baeyens
the RSI occur to the upside. Look at the large price drop past Point b and compare it to
the small drop in the RSI. From this information, we can determine that Point d must
be situated below the 40-level, where the RSI gets compressed.
Past Point d, the moderate price rebound causes the RSI to move up in an out-of
proportion way, which causes the formation ofthe (DD-). In the example, this means
thatthe RSI is approachingbearishterritorybecause it failedto escape from its descending
channel. In fact, we have already discussed this type ofsituation.
The appearance ofa first (DD-) within the descending channel marks the point where
the trend is about to change from up to down. In this case, the switch-overpoint has not
been reached, but the market is approaching the decision point. The (DD+) signal is
still valid because prices have not dropped below the support line and the RSI has not
dropped below Line L. On the other hand, the (DD-) signal is valid because price has
not climbed above the resistance line and the RSI has not broken out above the upper
boundary ofits descending channel. To put it simply, we are witnessing a bull-bear fight
on the edge ofbull-bear territory.
This condition will not occur at high RSI values. It typically develops in the area around
50, where both (DD+) and (DD-) signals have a chance offorming. The RSI is trapped
between the top of its descending channel, [keeping the (DD-) alive], and the rising
Line L, which is the limit ofvalidity ofthe (DD+). Ifno breakoccurs to either side, the
RSI will zero in on the 50-line, as long as the bulls and bears balance each other out.
Under these conditions, a triangle will emerge in the RSI. In price, the (DD+) support
line and the (DD-) resistance line often define a triangle or wedge-like formation until
the RSI and price break up or down, and the balance finally shifts to the bullish or
bearish side.
If the RSI breaks upward from its descending channel, it will reach bullish territory,
where a rising RSI means rising prices. As the RSI remains above 40 within its ascending
channel, a (DD+) signal will form, which means that we end up with two (DD+) signals
in this time frame. When prices finally rise above the Lighthouse level ofthe (DD-),
this signal is invalidated. As soon as the (DD-) signal is invalidated, the(DD+) can take
effect and the rally will continue.
If the RSI breaks below Line L, the (DD+) signal is invalidated and the (DD-) takes
effect as the RSI continues down within its descending channel. It will drop deeper into
bearish territory until it hits mathematical resistance and starts to curl up while prices
continueto fall, forming positive divergence. As price drops below the Lighthouse level
ofthe (DD+), this signal ceases to exist.
A few words about Line L: Each time a (DD+) signal forms, we should draw a line that
will define the limit ofthe validity ofthe signal. This ascending line should be drawn
parallel to the reference lines ofprevious ascending channels. In this case, we could
consider Line L to be the lower boundary ofa largerascending ChanneF, which might
be visible in a largertime frame. IfLine L is indeed the lower edge ofa large ChanneF,
we have an ascending channel, within which a (DD+) just formed. We know this
pattern; it is a typical uptrend.
130

Ifthe RSI breaks upwardfrom its descending channel, this marks the startofan ascending
channel, (or, in other words, the RSI is jumping into the next channel segment). Ifthe
RSI breaks below Line L, it drops below its ascending ChanneF, invalidating the (DD+)
signal. It would be interesting to look at the largertime frame in order to find out ifLine
L corresponds to a meaningful ascending channel and the level in which an anticipated
RSI break-down would occur.
Another valid (DD+) signal appears between Point a and b (a' and b' in the RSI). Past
Point b', the signal is invalidated. I would consider Point b (b') to be the failure point,
because the price retracement is still shallow up to this point and the RSI is not in
bearish territory. The RSI drops into bearish territory because it fails to escape from its
descending channel in time. The RSI has the chance to escape after the (DD+) signal
at Point b'. When a (DD+) signal fails, the RSI drops to the next (DD+), which has a
less steep support line and a more modest price target. That is what happens past Point
b'.
Figure 3.11 Daily OIX
This chart illustrates the configuration withinwhich opposing (DD) signals may occur.
The big picture ofa descending channel in this chart is clear. Ifthe RSI remains within
its descending channel long enough, it will end up in bearish territory and we may see
the formation ofa (DD-). The price retracement past Point X is deep enough that the
131

Walter J. Baeyens
RSI falls to the 22-level. Still, at the same time, the price retracement is shallow enough
to form a (DD+) along the lower boundary ofthe descending channel.
This (DD+) signal originates in bearish territory. We should be cautious and wait until
the RSI rises above 40. Also, it is clear that the upper boundary of the descending
channel barely reaches the 60-level. Even if the RSI is able to reach the top of its
channel, it will still be in bearish territory. Notice that most ofthe RSI advance, after its
bounce from the 22-level, is positive divergence. This means that the RSI will reach 60
with prices hardly moving up at all. This is the stuffthat (DD-) signals are made of!
In fact, we can see the formation oftwo (DD-) signals, one in the dashed sub-channel
starting at Point Y, and a larger one in the potential ascending channel originating at
Point X. Please note that Point X in the RSI coincides with the moving averages
crossover to the downside, as is often the case. For the (DD+) to take effect, prices
must rise above the (DD-) Lighthouse level at Point Y, which invalidates the minor
(DD-). We can consider this price area a resistance level. For the (DD+) to take
effect, the RSI needs to break up from its descending channel by staying in its new
ascending channel.
In price, the (DD+) support line and the (DD-) resistance line can be drawn, defining a
triangle. Ifprice breaks out from the triangle to the upside and rises above LevelY, the
bulls are in charge. We should see the formation ofa first (DD+) signal confirming the
market's bullish mood. If price drops below the triangle and the RSI drops below its
ascending channel, the (DD+) signal is invalidated and the (DD-) takes effect. This
happens while the RSI drops towards the lower boundary ofits descending channel. If
the bull-bear fightremainsundecided, prices will stay within the triangle, while the RSI
keepsmovingwithinthe triangular overlap area ofits descending and ascending channel,
(centered on the 50-level). In this example, the failure point is Point Y.
132

- Daiy PST L.483.25 -268 -0.55% 0..484.05 C=483.25
Created with TradeStation
Figure 3.12 Daily Semiconductor Index (SOX)
This chart offers another example of two opposing (DD) signals in the same time
frame. Point A marks a (DD+) signal within an ascending channel. This is a familiar
picture ofmarkets thatare trendingupward. Points B and C define another (DD+) that
confinns the rally. But at PointY, the RSI fails to rise into the next segment, (not unlike
an RSI Squeeze). The price advance after the (DD+) signal is so weak that a (DD-)
signal is fonned at Points Y and X. As a result, a Line W-Y can be drawn as the
potential upperboundary ofa descending channel.
Inthis example, we endwith twovalid(DD) signals. The (DD+) signal remainsvalid as
long as the RSI stays above Line A-C. The (DD-) signal remains valid as long as it
stays below Line W-Y. Line A-C and Line W-Y in the RSI converge around the 50-
level, demonstrating the market's indecision. In the price chart, the corresponding
support and resistance lines can be drawn to define a triangle, which are continuation
patterns. Nonnally, one would expect it to be broken to the upside. This time the bears
win the fight, which is not surprising after the RSI Squeeze. At Point Q, there is a last
ditch effort to save the (DD+) signal as price briefly bounces offthe (DD+) Lighthouse
level.
Shortly afterward, a new, tight (DD-) is fonned. The line ending in Point Z marks a
series of (DD-) signals within the descending channel W-Y-Z, as price slides twenty
percent lower. Within the descending channel, the RSI refuses to drop below the 30-
level and finally manages to break out from its channel as price rises above the (DD-)
resistance line.
133

Walter J. 8aeyens
It is important to remember that opposing (DD) signals in the same time frame do not
cancel each other. They tell us that the market is in a transition phase, where the fight
between bulls and bears is undecided. This fight typically takes place around 50 in the
RSI; the outcome of the fight could be a change in trend, as it might lead to an RSI
range-shift. Neither signal should be disregarded until it is invalidated, meaning that you
should not be tempted to rely on the most recent signal.
PART VII
CONFLICTING SIGNALS IN DIFFERENT TIME FRAMES
We have briefly discussedthe importance ofchecking RSI signals in smallertime frames.
Weakening ofthe trend will first be felt in the smaller time frame, resulting in signals
that are contrary to the predominant signals in the larger time frame. We know that
these early signals do not always point to an eminent trend change because they represent
a small vector pulling on the trend. But ifthey persist, they might reverse the vector of
the next larger time frame, which may spill over into the next larger time frame. So, if
we detect an opposing signal in the hourly time frame, we need to find out whether it
could push the RSI over the edge in the daily time frame.
The scenario for a trend change from uptrend to downtrend in the daily time frame
follows this progression: The RSI drops below its ascending channel and continues
down within its descending channel until it reaches bearish territory and the first
(DD-) signal appears. An early (DD-) in the hourly time frame will tell us that 1 ) the
price decline that caused it is deep and 2) the price bounce that followed is shallow
enough to assume that the price retracement down is not over.
While the price decline that caused the (DD-) in the hourly chart is not deep enough to
invalidate the (DD+) signal in the daily time frame, the next price decline could be.
When is a (DD+) signal in the daily time frame invalidated? Whenthe RSI drops below
its ascending channel. A (DD-) signal in the hourly time frame will is early indication
that this may happen.
If price reaches the target for this (DD-), the total price retracement down may be
deep enough in the daily chart to invalidate the (DD+). I repeat: The invalidation o
f
a (DD+) in the daily chart does not automatically mean the trend is changing. As
we have seen, ifthis happens high in bullish territory, it leads to the formation ofa more
modest (DD+) signal. The small hourly down-vector reduces the angle ofthe daily up
vector.
If the daily RSI is near 40 when an hourly (DD-) begins, this may mean the end ofthe
uptrend in the daily time frame. This scenario results in two vectors pointing down, with
the weekly pointing up but weakening or all three vectors pointing down as the price
decline accelerates. Anyway it is viewed, ifthe daily uptrend is to continue, it will have
to overcome the (DD-) signal in the hourly time frame by invalidating it. This means
134

that the daily (DD+) must be able to push price above the Lighthouse level ofthe hourly
(DD-) signal. Ifthe daily (DD+) fails in this test, a failed (DD+) is the result. We have
just studied two examples of what that might lead to. I refer to the failure points in
either ofthe examples in the previous section, where the failure ofprices to rally after
a (DD+) caused the extension and deepening of the retracement down to the point
where a (DD-) appeared within the descending RSI channel.
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Let's return to the Daily Oil Index Chart in Figure 3. 1 3. This is a chart I used earlier to
illustrate the interpretation oftwo contradicting (DD) signals in the same time frame.
We came to the conclusion that the failure point is Point Y. Here, a reversal up ofthe
RSI from the 40-level, could have led to a break-out of the RSI from its descending
channel. In this daily chart, prices have broken out from thetriangle and a (DD+) signal
has formed.
The RSI has broken the upper boundary ofits descending channel, so we may assume
that the RSI is now traveling within its ascending channel. The RSI is completing its
upward leg within the sub-channel that corresponds to the small (DD-) originating at
Point Y. Logically, the RSI will start a down leg, within its ascending channel toward
Point B. Here a new (DD+) signal could form, marking the resumption of the rally
after a mild price retracement. But, what ofthe failure at Point Y? Why was this the
"go-no-go" point and what must the daily RSI picture have looked like back then?
135

Walter J. Baeyens
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Figure 3.14 shows what the RSI picture looks like when the RSI reverses up at Point
Y, forming a (DD+) with reference Points Q and Y. Given this (DD+) signal, we could
have drawn a line through PointY in the RSI that wouldhave def
med the lower boundary
of an ascending channel if the (DD+) took effect. This line, together with the
corresponding support line in the price chart, would also mark the limit ofthe signal's
validity. This support Line Q-Y is quite steep,butthe(DD+) seems trustworthy generated
at the 40-level. Past Point Y, the (DD+) signal is invalidated.
Ifthe uptrend is to be saved, prices can not drop below Point Q, [the Lighthouse level
for the most recent (DD+)]. As the RSI reverses up at Point A, a new (DD+) signal
forms. However, it originates in bearish territory. In the RSI chart, there is theresumption
of an ascending channel from a lower RSI level. The same thing happened prior to
Point Q in mid-May of 2006, when a prior (DD+) signal was invalidated as the RSI
dropped to the 35-level. Within this RSI picture, we have two (DD+) failures and the
RSI cascading downward, breaking below its ascending channel each time.
The last time this happened, the RSI ended in bearish territory at Point A and the
rebound caused the formation ofa (DD-) signal. Consequently, it would be logical to
visualize the descending ChanneF, within which the RSI is cascading down by connecting
the RSI tops and the RSI lows.
The result in the RSI picture was discussed earlier in Figure 2.2 1 : The RSI is sliding
down in steps within its descending ChanneF. Please note the significance of the
moving average crossover points, both up and down, in the RSI.
Could we have had an early warning ofthe daily (DD+) failure at Point Y by
studying the hourly time frame? Let's have a look. I refer to Figure 3. 1 5.
136
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137

Walter 1. Baeyens
Figure 3 . 1 5 contains the failure Point Y, which is centered on the chart. At the beginning
of the chart, the RSI is moving within a descending channel, still enjoying a (DD+)
signal at the outset. This leads to a new high in price, but the rise is too steep to be
sustainable and the initial (DD+) signal is invalidated. Not surprisingly, this leads to a
new, more moderate (DD+) at Point A' (on the Lighthouse price level). Price rallies
past Point A, but the RSI is unable to escape from its descending channel. This weak
price rebound causes the formation of a first (DD-) in the descending RSI channel.
At this point, we have two conflicting (DD) signals in the same time frame. In price,
this bull-bear fight is visualized by a wedge formation sitting on the Lighthouse level of
the (DD+). In the RSI chart, the result appears in a triangle formed by the upper
boundary ofthe descending channel and the climbing LineA'-Y', [the limit line for the
validity of the (DD+)], and also the lower boundary of the potential new ascending
channel, in the event the (DD+) should take effect. Both lines converge in Point Y' ,
which is very close to the 50-level. Between Point A' and Point Y', the RSI drops
below the Line A'-Y', indicating that it is staying within its descending channel and
entering bearish territory as the (DD-) takes effect.
This means that there is probably going to be another (DD-). In price, the Lighthouse
level A-B is broken at Point B, invalidating the (DD+) signal. Consequently, the next
RSI rebound off the lower boundary of its descending channel does not produce a
(DD+). Instead, a second (DD-) appears at Point Y because the RSI made an out-of
proportionjump while price hardly moved. This second (DD-) takes effect as the RSI
drops into the next segment within its descending channel and price cascades lower.
Past Point D', a positive divergence lifts the RSI back into bullish territory, but the
extended Line A'-Y' defines a (DD-) along the upper boundary ofan early ascending
channel. Inside this ascending channel, a (DD+) signal is formed on October 2 and 3,
marking the point where the overhanging (DD-) is possibly failing. These opposing
signals result in a price triangle that is broken to the upside later in the chart.
Refer back to the daily chart in Figure 3. 1 4.
Had we checked the hourly chart when the (DD+) signal formed in the daily chart, we
would have noticed that the shallow price decline preceding the formation ofthis daily
(DD+) signal was deep enough to cause the formation of a (DD-) in the hourly time
frame. While the (DD+) signal in the daily time frame forms around the 40-level, the
corresponding hourly RSI is well within bearish territory. As a result, the daily (DD+)
signal has to overcome the hourly (DD-) signal in order to take effect. Ifa (DD+) signal
ofthe daily magnitude is unable to overcome a (DD-) signal froma smaller time frame,
it is going to fail. In the hourly chart, we should see the RSI escape from its descending
channel and price should rally above the Lighthouse level of the hourly (DD-) with
ease, followingthe(DD+) inthe dailytime frame. This didnothappenandit is interesting
to note that the failure in the hourly chart occurs when the RSI fails to continue up from
the Line A'-Y', and consequently breaks the RSI triangle to the downside. I would not
be surprised to find an early warning for this hourly (DD+) failure in the I S-minute
chart!
138

RSI: Logic, Signals & TIme Frame Correlation
In the daily chart, the failed (DD+) signal forms near 40. As it fails, the RSI drops
below its validity limit line and immediately enters bearish territory as the decline in
price accelerates.
What have we learned about the interpretation of opposing (DD) signals in different
time frames?
The larger time frame (DD) signal is typically stronger than the (DD) signal emerging
in the smaller time frame. Still, for the larger (DD) to take effect, it must override the
smaller one; the shallow price retracement preceding the formation ofthe larger (DD)
signal is deep enough to cause an opposing signal in the smaller time frame. If the
smaller (DD) is allowed to take effect, this means the price retracement is going to
become even deeper, possibly even deep enough to invalidate the larger (DD). If the
larger (DD) signal occurs near the edge of bearish or bullish territory, the effect ofthe
smaller contrary (DD) may be quite significant.
In conclusion: When a (DD) signal is detected, check the smallertime frame for contrary
(DD) signals. Ifone is found, check its price target and examine what could happen to
our larger (DD) signal if prices move to this target. It is assumed that the larger (DD)
will take effect afterthe smaller (DD) signal is invalidated and price breaks the Lighthouse
level ofthe smaller conflicting (DD) signal.
The same logic is used for opposing signals in the same time frame. W
ait until one of
the signals is invalidated. However, this time we are unable to draw a triangle to
visualize the conflicting forces at work. The smaller (DD) Lighthouse level could be
displayed in the larger time frame chart to mark the price level beyond which the larger
(DD) will take effect.
This principle can be applied to any pair of time frames and the conclusion can be
correlated to a third time frame. In this scenario, the middletime frame, (the daily time
frame), could be called the "reference time frame." The smaller hourly time frame
should be checked for any contrary signals and the larger weekly time frame should be
checked for the daily signal that aligns with the larger trend. The trend is strongest
when all three vectors point in the same direction. The appearance ofa contrary signal
in the smaller time frame may be a sign oftrouble ahead, until the effects ofthe larger
one invalidate the contrary signal.
What can we conclude from our RSI analysis in the daily and hourly XOI charts? And
how can this be related to the RSI picture in the weekly time frame?
We have learned that the daily RSI is moving within its ascending channel and that this
channel originated in bearish territory. We also know that this ascending channel is the
last of a series of ascending channels that were all broken to the downside. These
channels look like lowersteps within a larger descending ChanneF, [which has produced
a (DD+) signal], but the market reaches bearish territory and the most recent ascending
channel within it defines a contrary (DD-).
This tells us that the trend is in a transitional phase and the RSI must escape from its
descending ChanneF in order to avoid a downward trend reversal. One way for the
139

Walter 1. Baeyens
RSI to escape from its descending channel is to stay within the new ascending channel,
as we have seen price exceed the Lighthouse level of the hourly (DD-) and a (DD+)
appear in the ascending channel.
We also anticipate thatthe RSI will drop to the lowerboundary ofits ascending channel
sooner or later, forming a (DD+) near Point B in Figure 3. 1 3. This Point B in the RSI
is situated around the 35-level, which is on the edge ofbearish territory. A repeat of
previous (DD+) failures at this point will quickly put the RSI back in bearish territory.
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Figure 3.16 Weekly XOI
The descending ChanneF detected in the daily chart corresponds to the descending
sub-channel developing throughout 2006. What do we see? The RSI is in bullish
territory, reversing up from the 40-level atthe lowerboundary ofits ascending ChanneF.
There is a giant (DD+) signal [or series of(DD+) signals], inside this ascendingChanneF.
This is a textbook uptrend, as long as the RSI stays within this ChanneF.
On the other hand, there is a giant negative divergence def
ming the upper boundary of
the descending channel. This is not a problem, as long as the divergence does not push
the RSI into bearish territory. So far, it has not and there are no (DD-) signals within
this descending channel. Still, the RSI has not made its way into the next channel
segment. We can look at the negative divergence from two sides:
I ) It has taken the RSI lower without declining prices. Ifthe RSI resumes its
climb within its ascending ChanneF, the rally is going to continue or accelerate,
cr
2) It has taken the RSI to the limit ofbearish territory and may push it over the
edge.
140

Both views are valuable. In the chart, this duality is expressed by the RSI driving into
a triangle, formed by the descending line ofthe negative divergence and the ascending
lower boundary of its ChanneF. When extended to the right side of the chart, these
lines cross near the 50-level.
Also, the upper boundary ofthe descending channel only reaches the 60 to 65 level, so,
for the latest (DD+) totake effect, the RSI will need to break out from this channel. On
the other hand, this (DD+) will be invalidated ifthe RSI should drop below its ChanneF.
This is the essence ofthe RSI triangle dilemma: Which way is the RSI going to break?
For now, the weekly picture is bullish. If another (DD-) signal appears in the daily
chart, it would indicate thatthe recent weekly (DD+) signal might fail.
The weekly RSI needs to break from its descending sub-channel before even attempting
to escape from the larger channel around the 60-level. The daily chart indicates that
the RSI will probably declinef
rom here in order to test the lower boundary of the
ascending channel. At the boundary, it should form a (DD+) signal, which should propel
it back into bullish territory. At this time, it looks like the weekly RSI is not going to
escape from its descending sub-channel soon. A new (DD+) signal in the daily seems
to be required first. This time, the failure ofthis upcoming daily (DD+) could be real
trouble!
In the weekly price chart, the most recent (DD+) signal indicates a weakening or
flattening out ofthe uptrend. If the RSI declines from its present position as the daily
chart suggests, it heralds the formation ofa giant Head & Shoulders. This should come
as no surprise, as the descending sub-channel is approachingbearish territory andwithin
this sub-channel, the last RSI rise only got to the 56-level, meaning no higher high in
price on the right shoulder.
Another example ofconflicting (DD) signals in different time frames can be found in
the next pages, where we examine the daily and hourly crude oil futures charts.
141

Walter 1. Baeyens
ZOO<O) - Deiy NYhEX L-6012 -02. -0._ 8-60.12 A<60.17 0-60.30 twO.56 L..60oo C<60.12 V063<8
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and the corresponding reference lines. We considerthis daily chart to be the "reference"
time frame and correlate it to the hourly and weekly charts. In the price chart, there is
an uptrend goingwith a significant correction down toward the right edge ofthe chart.
We should expect to f
md (DD+) signals within an ascending channel, but the general
aspect of the RSI picture appears to be a large descending channel. A look at the
weekly chart confirms this view.
142

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At the beginning of a descending channel, the lower boundary often defines (DD+)
signals, (for instance, in the case of a negative divergence). We also know that if the
RSI fails to escape from its descending channel, it will end up in bearish territory. This
is what we see happening in September 2006, as the RSI reaches a low around 1 5, deep
in bearish territory. It looks like we could be on the verge of a range-shift and trend
reversaL Where did things go wrong?
143

Walter J. Baeyens
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144

Note that the dotted line in the RSI chart, originating in May of2005, is the lower
boundary ofan ascending channel that followed the initial (DD+) signal. The RSI
dropped below this line in September 2005 but at Point X, the RSI formed a more
modestsecond(DD+), marking the start ofthe ascendingchannel thatremainedintact
untilAugust of2006. Within this channel, there are two (DD+) signals.
InAugust 2006, when RSI breaks down from its channel, we would expect to see the
RSI dropto the nearest (DD+) reference line and start a new ascending channel from
there, similar to what happened at Point X.
As we see price drop below the latest (DD+) support line in August 2006, while the
RSI drops below its ascending channel, the conclusion is that the latest (DD+) is too
ambitious and that the RSI is going to form another (DD+) at a lower level, when the
rally should continue. This should have happened at Point A (Point A' in the RSI).
Price reached the (DD+) support line and the RSI reversed up from the extended
reference line ofthe previous (DD+) around the 35-level.
Up to that point, it looks like the rally is startingits next leg upward. Normally, at Point
A: , we would have drawn a line parallel to the previous boundaries ofthe ascending
channel. I have deleted this line to avoid cluttering the chart. The RSI was expected
to remain above this line, within its newly defined ascending channel as the rally
continued. At Point A', the RSI is on the edge ofbearish territory and ifthe (DD+)
fails, bearish territory is immediately entered.
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The hourly chart shows that prior to the potential (DD+) in the daily chart, the RSI
forms the first (DD-) in mid-August and the second (DD-) should form soon, unless
price exceeded the Lighthouse level at $74. The RSI fails to break from its descending
channel in late-August and early-September 2006. Consequently, the RSI drops into
the next lower channel segment within its descending channel as the (DD-) signal takes
effect. By then, the upper boundary ofthe descending channel is at 60, which leads the
RSI further into bearish territory. As the chart shows, the price decline then accelerates.
At the time of the emerging (DD+) in the daily chart, we knew that the price decline
preceding the (DD+) signal was deepenough to cause a conflicting (DD-) in the hourly
chart. For the (DD+) to take effect, it had to override the hourly (DD-). This means
that the daily (DD+) would take hold, ifit could push prices above $74. After that, we
could expect price resistance around $77, [the Lighthouse level ofthe previous (initial)
hourly (DD-) signal].
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Figure 3.22 Weekly Crude Futures (the big picture behind the daily and hourly signals)
Figure 3.22 illustrates the ascendingchannel originating from Point X in the daily chart.
It corresponds with the ascending channel defined by Line C-X in the weekly time
frame. The RSI breaks to the downside from its initial ascending channel after a
negative divergence. (This is the beginning ofthe descending channel detected in the
general picture ofthe daily chart). As expected at Point C, a new (DD+) forms. The
rally continues unchallenged, while the RSI manages to stay within its new ascending
channel. The RSI is unable to break the negative divergence in the daily chart, and at
Point X, it breaks down from its ascending channel. Point X in the weekly chart coincides
146

with the failed (DD+) at Point A' in the daily time frame. In this weekly chart, Point X
is situated near the RSI 50-level.
A contrary signal in the hourly time frame should be taken seriously. Its existence is
significant, as it is proof that the price retracement is deep in this time frame. If an
hourly signal is not invalidated by a larger signal, it will take effect, possibly deepening
the price retracement enough to invalidate the larger daily signal. These effects may
eventually spill over into the weekly time frame.
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Figure 3.23 Daily S&P 500 Index
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Figure 3.23 illustrates a clear uptrend in price. However, the RSI ChanneF is descending
and a negative divergence is defined by the upperboundary ofthis ChanneF. Along the
lower boundary, there is a (DD+) signal in October 2005 and another at Point A.
However, at PointA, the RSI low is below 40, (which comes as no surprise, considering
the presence ofthe descending ChanneF). The RSI rebound from Point A leads to the
formation of a (DD-) signal at Points X and Y. In price, these contrary. signals are
expressed by the triangle-defined by Line X-Y at its top and the (DD+) support line at
its bottom.
In the RSI, (dashed) Line X-Y defines a new, steeply rising ascending channel. The
angle ofLine X-Y suggests thatthis is a sub-channel within a (moremoderate) ascending
channel. Past Point Y, the question is: Will the RSI manage tobreakout ofits descending
channel? Ifit fails to break out, the RSI is in danger ofdropping below its sub-channel
X-Y. This means that the (DD-) signal is taking effect, indicating lower prices.
Surprisingly, the RSI manages to stay within its steeply ascending sub-channel and
147

Walter 1. Baeyens
price breaks to the upside from the triangle. Subsequently, as price rallies above the
(DD-) Lighthouse level at Point X, this (DD-) is invalidated.
In October 2006, the RSI approaches the upper boundary of its descending ChanneF.
At some point, the RSI should start a down-leg to the lower boundary ofits ascending
channel, which begins at Point A. However, the RSI moves upward and negates the
descending ChanneF. We should expect the RSI to continue moving higher within its
ascendingchannel, where it may form a (DD+) when it rebounds from its lowerboundary,
well above the 40-level.
Let's assume that the RSI forms a (DD+) signal at the lower boundary ofits ascending
channel, aftercompleting a down-leg within a sub-channel. Ifthis (DD+) is situated on
the declining line running through Point Y, we can conclude that price should not be
lower than (approximately) 1 300 when the RSI reverses up from the lower boundary of
its ascending channel. This makes the formation ofa (DD+) signal a plausible scenario.
What does this look like in the hourly time frame?
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"Sub-Channel" in this hourly chart. Not surprisingly, we find several (DD+) signals
confirming the uptrend. Strangely, the RSI is unable to rise above 75 - a respectable
level in this time frame, given that price reaches new highs each time the RSI hits this
level. Still, a strong uptrend should be able to push the RSI up to the 90-level in the
hourly time frame. If the RSI is unable to break above 75, it will be pushed below its
148

ascending channel. This should definitely be monitored, as the RSI should start its
down-leg in the daily chart very soon.
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Deated wih T,odeStation
Figure 3.25 Hourly SPX (continued from Figure 3.24)
In early November 2006, the lower boundary ofthe ascending channel is violated by the
RSI. This indicates that it may start a new descending channel along the reference line
of the most recent (DD+). In the daily chart, this is where the RSI drops below its
steeply ascending sub-channel, marking the beginning ofits anticipated down-leg. The
hourly RSI confirms this when it fails to reach 75, indicating that the new descending
channel is its boundary.
The hourly RSI drops to the bottom ofthis channel, which is well within bearish territory.
The RSI rebound from the 25-level produces a (DD+) signal. However, the chart
shows that the descending channel will limit the RSI advance to the 60-level, where a
(DD-) signal will form. Since it will be the first (DD-) signal to form in several weeks,
this signal is significant. Rememberthat we anticipated the formation ofa (DD+) in the
daily chart. This could mean that we end up with conflicting signals in different time
frames. In other words, the daily (DD+) is unreliable until it succeeds in invalidating the
potential hourly (DD-).
149

Walter J. Baeyens
XJ<(D) - Doiy COOE L·1381.9J -D.� -DOO% 801381 .62 A·1382.50 O.QJXl �.OO LCFO.oo C·1381$ Y.Q
Figure 3.26 Daily SPX
1 ,340.00
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As anticipated, the RSI starts its down-leg inside a descending sub-channel (on its way
to Point B). This does not lead to a lower high in price, as we are witnessing the start
of a negative divergence. At this point, a reversal upward in the RSI will produce a
(DD+). Assuming that the RSI is going to climb to the top of its sub-channel, which is
situated near the 70-level, we can expect to see price reach (or even exceed) the
previous high. However, a (DD-) signal is likely to form in the hourly time frame. How
could the upcoming daily (DD+) invalidate the hourly (DD-)? The rebound in the
hourly chart could continue upward and cause the RSI to break out from its descending
channel.
Now, refer to the triangle (in the price chart) defined by the reference lines ofthe two
contradictory (DD) signals. Iftwo opposite (DD) signals are detected, the most recent
one is not automatically the one that should take precedence. In this case, the (DD-)
signal generated at Points X-Y is invalidated, even though it is a tight, strong signal.
When two contradictory signals are valid, wait until one signal invalidates the other.
156

XJ«ll)-_ ceo€ L-1377.94 oD.OO oD.()()';, 8-1376.72 A-1378 10 0-0.00 _.00 Lo=O.OO C-1377.94 V-o
Figure 3.27 Weekly SPX
This chart is the background information behind the daily and hourly charts. In 1 999
and 2000, we see the formation of a triangle in the RSI. As the RSI breaks from the
triangle to the downside, a bearish market develops in 2001 and 2002. In Quarter 3 of
2002, a positive divergence marks the start ofan ascending RSI channel, which carries
the RSI into bullish territory. In Quarter 3 of2004, a (DD+) signal forms, confirming
the trend reversal. The RSI stays within its ascending channel as prices advance, but a
negative divergence extends from 2004 to 2006.
The negative divergence corresponds tothe descending channel in the daily time frame.
In fact, the RSI is unable to rise above 65 for two years. The RSI drops below its
channel in mid-2006; this is an RSI break-down from the triangle, like the one seen in
2000. The RSI rebounds from the40-level and continues upward, breaking the negative
divergence and rising above 65. In the daily chart, this corresponds to the unexpected
break (in RSI) in the upperboundary ofits descending channel, which is rather unusual.
Because the RSI has not dropped below 40 for the last three years, the daily and hourly
scenarios previouslystudiedmust be againsta bullish background. It looks like the rally
should get new energy as the weekly RSI breaks above 65 (after being confined in the
range from 40 to 65 for three years). In the near term, the (DD-) signal in the hourly
time frame should be monitored. Is it going to be negated by the Larger daily (DD+), or
is this the first sign oftrouble?
151

Walter J. Baeyens
SSPX.X(D) · Daiy CBOE L-1399.48 +12.16 +0.92% 8=1396.76 ,0-1399.75 0-1386.94 HI.1401 .14 Lo-1386.94 C.1399.48 v-a
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Figure 3.28 shows the daily SPX chart from November 30, 2006. As expected, the RSI
reverses upward from the lower edge ofits sub-channel, forming a (DD+) signal well
above the 40-level. Price rebounds nicely from the (DD+) support line. It is clear that
new price highs will be reached, if the RSI continues up to the upper boundary of its
sub-channel, around 70. Apparently, this is the start of a negative divergence. What
does this look like in the hourly RSI chart?
152

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Figure 3.29 Hourly SPX (December 1 , 2006)
In Figure 3.29, the recent rebound in the market can be studied in detail. The RSI
reverses upward from its descending channel (from around the 20-level), which
corresponds to a rebound offthe 49-level in the daily chart. This means that the recent
price retracement within the daily picture is shallow, while it is relatively deep in the
hourly time frame. We anticipate that the RSI will bounce to the top ofits descending
channel, corresponding to the sub-channel down-leg in the daily (around the 60-level),
only to form a (DD-) signal.
Because ofprice action, the RSI reaches the top of its channel, and price reaches the
prior high level. This is called a "timid" (DD-) signal. The RSI does not break out from
its descending channel. However, ifit doesn't break out soon, the daily (DD+) will not
take effect and its price target will not be reached. Ifit does break out, we ask: Will the
RSI be able to rise above 75? For now, it looks like the RSI is traveling within its
descending channel. Ifit continues down from here, we may see a lower low in price.
For the daily (DD+) to take effect, the hourly RSI needs to break from its descending
channel first. Ifwe are looking for an opportunity to go long on the SPX, the hourly RSI
has to break out first.
153

Walter 1. Baeyens
XX(D) - 60 .m CBOE L.1396.71 -3.94 -016% 8-1395.93 A.1396.92 0.1400.63 H.1402.46 Loo1J85.93 C.l396.72 VOO
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Figure 3.30 Hourly SPX (December 2, 2006)
The RSI is meandering within its descending channel; for the (DD-) to take effect, the
RSI must continue down within this channel, dropping below the lower dotted line into
the next lower segment. We also know that there is a (DD+) in the daily time frame.
In this time frame, there are two conflicting (DD) signals. There is a weak (DD+)
signal (originating in bearish territory) and a timid (DD-) signal. For the former to take
effect, the RSI needs to break out to the upside. For the latter to take effect, the RSI
must drop below the lower boundary (dotted line) ofa potential new ascending channel.
If we mentally extend these reference lines to the right, we can imagine a triangle
centered on the 50-level. Let's wait and see which way the RSI breaks out. In the
hourly price chart, this could correspond to the formation ofatriangle, orwedge formation,
with prices cornered between the rising (DD+) support line and the 1 400-level. The
market bias has to be bullish because the RSI vectors in both daily and weekly time
frames are still pointing up.
154

RS!: Logic, Signals & Time Frame Correlation
X.lI(D) - Doiy CBOE L·1423.53 -2.02 -0.14% B-H23.12 A·1424.19 0-1425.66 ti-1429.os La-1423.51 C.1423.53 V-o
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Figure 3.31 Daily SPX (December 2 1 , 2006)
The RSI continues its bounce offthe sub-channel (DD+) reference line, pushing prices
to new highs, well above the price support line. The RSI is ready to start its decline into
area B at the bottom of its ascending channel.
155

Walter 1. Baeyens
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Figure 3.32 Hourly SPX (December 2 1 , 2006)
Followingthe (DD-) signal atthe end ofNovember, the RSI breaks above its descending
channel, (circled) and appears to enter an ascending channel. Here, a (DD+) signal
forms, while price rallies from the 1 400- to 1 430-level.
The RSI Squeeze at the 75-level is violated, soall the bearish elements have disappeared.
Ifthe RSI is going to continue down [to reverse up offthe (DD+) reference line], prices
are not going to fall below the support line at 1410. The first sign oftrouble will be when
the RSI drops below its ascending ChanneF. When that happens, troubles will quickly
get worse ifthe daily RSI breaks below Line A-B!
156

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A few weeks have passed since our last analysis of the SPX chart. The RSI has
moved lower, reaching the target circle on LineA-B within the descending sub-channel.
The negative divergence has pushed the RSI lower, but it is still in bullish territory at the
48-level. We know that the RSI must escape from its descending sub-channel in order
to continue the rally. LineA-B is the lower boundary ofthe ascending channel; we will
need to monitor whether or not the RSI will manage to stay in it.
Ifthe RSI is unable to stay within the ascending channel, we can assume that the drop
in RSI values will continue to the (DD+) reference line, while price drops to the 1 390
area. When the RSI reverses upward from that line, there will be a new (DD+) signal.
However, the rebound will not take price to new highs unless the RSI manages to break
out. This is an interesting example ofTime Frame Correlation; we need to determine as
soon as possible ifthe daily RSI is going to drop below Line A-B. If this happens, the
RSI could continue down to the dotted Line A-C, (the lower boundary of a potential
ascending ChanneF). Until now, we have considered a descending ChanneF. However,
since the RSI breaks its upper boundary in October 2006, this indicates that the RSI
may start a new ChanneF. An RSI break below Line A-C, which is situated near the
40-level, would be a significant sign offuturemarket activity.
157

Walter J. Baeyens
XJ«O) - SO mil CBOE L.140971 -8.63 -ll.61" 8-140924 A·1410.� Oo1m.58 It-H17.58 Lo-1405.75 <:-1409.71 V-O
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Figure 3.34 shows that the RSI rallies above 40 after positive divergence develops.
This positive divergence indicates that the RSI in the daily chart will probably not drop
below Line A-B without an attempted rebound. The RSI is cornered in a triangle
[defined at its lower edge by the dotted positive divergence line and at its upper edge by
the next RSI segment line running parallel to the latest (DD+) reference line]. This RSI
triangle, when broken, will give us an early indication ofa potential cascading effect in
the daily picture. Also note that the upper dotted line defines a timid (DD-). This is a
timid signal because the corresponding reference prices are nearly equal.
158

RSJ: Logic, Signals & TIme Frame Correlation
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Figure 3.35 Hourly SPX (January 1 1 , 2007)
Here, the RSI breaks out ofthe triangle to the upside. Ifthe RSI is traveling within its
ascending channel (dashed lines), it should soon break the top ofthe descending channel.
This represents an important signal, asit indicates that the negative divergence is breaking.
This could happen in the next session. But, we may see the RSI decline to Line Q-R
first, or even lower, forming a (DD+) signal within the ascending channel near Point S.
In the RSI chart, notice that the boundary lines ofthe two candidate channels converge
at the 50-level. Given the uptrend and the recent RSI break-out to the upside, the
ascending channel is now our main reference.
159

Walter 1. Baeyens
XJ«D) . Doiy CllOE L·1423B2 .aS7 .0.63% 6-1423.31 A·142418 00141571 "" 427.'2 L,.1415.66 C·1423B2 V-O
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Figure 3.36 Daily SPX (January 1 2, 2007)
160

Figure 3.37
PART VIII
PROJECTED PRICE TARGETS REVISITED
...
...
... ...
We know how to calculate a price target, starting from the (DD) reference price levels.
What else can be said about probable future price activity when analyzing the RSI?
When the market is in an uptrend and the RSI drops below its ascending ChanneF,
which price target level can we anticipate?
Figure 3.37 illustrates such a situation. The RSI is initially traveling within its ascending
ChanneF, forming consecutive (DD+) signals. In this example, the last (DD+) forms at
Points A and B. Typically, the RSI will violate the boundary before breaking down in
the next cycle. Ifthis happens deep in bullish territory, with RSI tops around 80 to 85,
we can assume that the RSI is temporarily shifting to a lower gear, dropping to a new,
less ambitious (DD+).
When the RSI breaks below its ChanneF, the reference Line A-B [of the most recent
(DD+) signal] is extended; we can presume that the RSI will reverse there. Why? In
an uptrend, a new (DD+) will form as long as the RSI stays above 40. (You may want
to check the next larger time frame to confirm). Consequently, ifan RSI reversal up at
Point C is anticipated, forming a (DD+) signal above 40, we know that price at Point C
will not be lower than at Point A. If it were lower, there would be no new (DD+) at
Point C.
161

Walter 1. Baeyens
When the RSI drops below its ChanneF, price will not initially drop to a lower low. This
is the basic concept behind a (DD+): a reversal up after a shallow retracement down
in an uptrend. If a long position had been taken after the first (DD+), the stop-loss
order can be moved to the price level corresponding with PointA. This is because price
will not drop below this level, as long as the uptrend remains intact in this time frame.
Ifthe RSI continues down within its descending channel, past Point C, the situation will
change. We know that descending channels, even ifthey define (DD+) signals, will
initially lead the RSI into bearish territory. This corresponds withthe fact that the price
decline will not break the (DD+) Lighthouse level, ifthe uptrend is to continue. Ifprice
falls below the (DD+) Lighthouse level, this means that the price retracement down is
not shallow in that time frame and price is less likely to reach higher highs. Note that
this scenario applies to cases where the RSIstartsf
rom a strong position. It is not
to be applied after an RSI Squeeze, which sees the RSI surrenderingf
rom a position
of weakness.
Of course, it is possible that the RSI break-down from its ChanneF was preceded by a
(DD-) signal in the smaller time frame, which would allow the calculation of a more
precise price target. This price target could be correlated to the price estimation just
discussed. In other words, the projected price retracement from this (DD-) could
possibly qualify as a shallow retracement in the larger time frame.
X· 60 min NASDAQ l-SO.98 -1 .62 ·3.08'% 8-50.99 A-51.S9 0-52.19 1-1-52,89 lo-SO.55 Ca51.S9 V.4736001
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Figure 3.38 Hourly LRCX
162

RSI: Logic, Signals & T
ime Frame Correlation
The RSI travels within its ascending channel until October 20th, when it violates its
lower boundary for the first time. This causes the formation ofa (DD+) signal, but it is
clear that the RSI is not strong enough tojump into the next channel segment. By the
end of October, the RSI drops below the channel again and the (DD+) reference line
takes shape as the lower boundary of a descending channel. Past Point X' (at the
center-right of the chart), the RSI surrenders and falls below the ascending channel
line. We should expect the RSI to drop to the nearest (DD+) reference line, because
the uptrend should continue. This happens as expected, but the RSI reversal up occurs
well within bearish territory. Prices edge lower as the RSI curls up and builds a positive
divergence along the (DD+) reference line, (which is now the bottom of the new
descending RSI channel). Prices hold nicely above the main (DD+) support line.
Since, anew (DD+) signal develops in early December, a tentative line can be drawn in
the RSI chart, parallel to the previous ascending channel. This line shouldprove to be
the lowerboundary ofa future ascending channel, (assuming that the RSI break-down
is not affecting the uptrend, but rather a preamble to a new RSI run). At this point, we
know that the RSI is meandering within its descending channel, so what can be said
about future prices?
Look at the distance traveled upward by the RSI from the lows early in December.
The upward move in the RSI is out-of-proportion with the rise in price. This is not
surprising. As the RSI crosses 50, this effect will lessen and the RSI will compress
when it approaches the 70-level. It is unlikely that prices will reach $56 by the time the
RSI hits the upper boundary ofits descending channel near the rectangle on the chart.
However, ifthe RSI reaches the rectangle with prices below $56, a (DD-) signal forms.
This happens as a consequence ofthe RSI drop below its ascending channel. It could
be the beginning ofa descending channel and it could cause a reversal (DD-), and even
possibly invalidate the most recent (DD+).
Ifa long position is taken, following this last (DD+) signal, we should be aware that the
rally could run into trouble at price level X, the Lighthouse level ofthe potential (DD-).
Imagine the RSI reversing down from the rectangle; ifthis occurs we probably have a
(DD-) signal (with the RSI staying within its descending channel). If this (DD-)
materializes, we will have two conflicting (DD) signals in the same time frame. A
triangle is forming in the RSI (centered on the 50-level). Look at the upper boundary of
the descending channel. The RSI value on the right edge ofthe chart reaches 68. The
rising lower boundary ofthe potential ascending channel reaches 32. These lines are
converging symmetricallytowardthe 50-level, forming a triangle. How does this hourly
picture relate to the larger daily background?
163

Walter 1. Baeyens
X - Doly NASDAQ l-S3.67 -0.11 -0.20'% 8-53.67 A-S'HS 0-0.00 Hi.(l,OO Lo-OOO C-sJ.78 V-O
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30.00
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Figure 3.39 Daily LRCX
The positive divergence and RSI rebound examined in the hourly chart produced a
(DD+) signal in the daily chart, well above the RSl 40-level. The recent price decline
that pushed the RSI into bearish territory in the hourly chart corresponds to a shallow
retracement in the dailychart, causing a (DD+) signal to form well within bullish territory.
The big picture presented is bullish. What else can be said about the daily RSI picture?
We have a descending channel (negative divergence) taking the RSI to the edge of
bearish territory in July 2006. There is a (DD-) signal in September 2006; the conflicting
(DD) signals form a triangle formation in price that is broken to the upside. The RSI
violates the upper boundary ofits descending channel in October. The circled violation
provides an indication that the RSI might escape and continue up within its ascending
channel. Price is well above the main (DD+) support line and reaches a new high.
This means that the RSI has yet to reach the point where a Head & Shoulder formation
occurs in price. Also, we see the RSI meandering within a sub-channel on the down
leg, inside its descending channel.
Ifthe daily RSI continues up to the upper boundary ofits sub-channel around 65, price
should reach (or even exceed) the prior high. However, in the hourly picture, the $56
resistance level in price must be exceeded first, invalidatingthe hourly (DD-). There is
a (DD+) in the daily uptrend, but a (DD-) signal in the hourly needs to be invalidated for
the rally to continue. We can expect prices to initially rally to $56.
164

RCX · 1 5min NASD....Q l-50.98 -1.62 -3.08% 8-50.99 ,A.-51 .59 0..52.19 Hi-S2.89 Lo-SO.55 C=5159 V.4736001
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Figure 3.40 I S-Minute LRCX (Chart # 1 )
I s there a warning prior to Point X? What potential (00-) is looming in this time frame?
Apparently, there is no (00-) signal in the I S-minute time frame (prior to Point X) that
could be used to calculate a price target if the RSI dropped below its channel. The
positive divergence detected in the hourly chart is also visible in this chart. It has
pushed the RSI over the 40-level, even though price has hardly moved up. Also, the
recent RSI rebounds, which caused the positive divergence, have formed a (00-)
signal at Points X' andY'.
Opposing (00+) and (DO-) signals at Point Y allow for a triangle in price (dashed
lines). Price breaks this triangle to the downside, past Point Y. The recent out-of
proportion rise in the RSI will probably result in another (00-) signal, forming around
Point Z'. In the short distance that is left for the RSI to reach Point Z', I do not expect
price to rise above $54. This is the Lighthouse level for the (00-) signal. We can
expect a new (00-) in this time frame, with $54 as a resistance level.
If this (00-) signal takes effect at Point Z', the hourly RSI will reverse down before
rising further. In this respect, the I S-minute chart provides an early warning ofwhat is
likely to happen in the hourly chart. Price resistance levels are $54 and $56. Before the
resumption ofthe rally, the i s-minute RSI mustbreakoutto the upside from its descending
channel, or the RSI needs to form a (00+) signal within its new ascending channel X'
Y'-Z' after a shallow price retracement.
165

Walter 1. Baeyens
· 1 5 min NASDAQ l-53.78 +0,00 +0,00% B-O.OO A-56.67 0-0.00 Ii-o.ooLo-O.OO C-53.78 V-O
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Figure 3.41 I 5-Minute LRCX (Chart #2)
The RSI reaches Point Z', while price rallies to the $54 level. Note that most of the
gains in price occur while the RSI is compressed at the upper boundary ofits ascending
channel, around the 75-level. Another (DD-) signal hasjust formed at Points Y'-Z',
well within bullish territory. Next, we need to monitor whether the RSI is going to break
out to the upside from Point Z' or a mild decline in the RSI will cause the formation of
a (DD+), from which we could see price break above $54 (on its way to $56).
166

X - iSm NASDAQ l-53.67 -0.11 -0.20% e-so.so A-s6.87 0-0.00 tfaO.OO Lo-ODJ C-53.76 V-o
57.00
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Created with TladeStation
Figure 3.42 I S-Minute LRCX (Chart #3)
Figure 3.42 is the next snapshot in the series ofLRCX I S-minute pictures. In the area
around Point Z' in the RSI chart, some negative divergence forms. This results in a
price violation ofthe Lighthouse level, while the RSI fails to exceed the upper boundary
ofthe descending channel. This channel is the validity line for the (DD-) signal. As the
upward price pressure subsides, the RSI drops in an out-of-proportion way. Its reversal
up at Point R' produces a (DD+) signal, in reference to Point Q'. (This was expected
in the event the RSI did not break out to the upside at Point Z').
From Point R', the RSI could continue back up to the upper boundary ofits ascending
channel, taking price to a new high, in the $56 area. This is the most bullish scenario.
This would mean that the RSI in the hourly time frame reverses up and starts climbing
to the upper boundary ofits descending channel, where it might form a (DD-) ifprice
fails to exceed $56.
But there is an alternative, less exuberant scenario. In the I S-minute chart, the RSI
may continue to the lower boundary ofits ascending channel (in the vicinity ofPoint S'),
where it may form a new, more modest (DD+) signal. Line Q'-R'-S' def
mes a plausible
(DD+) reference line, indicating that price is not expected to drop below price level Q.
Ifa line is drawn from (price) Point Q, parallel to earlier (DD+) support lines, we get a
good idea ofwhere Point S may be on the price chart.
We do not have to worry about the uptrend unless the RSI drops below its ascending
channel. This would invalidate the recent (DD+) signal, telling us thatthe RSI is unable
167

Walter J. Baeyens
to escape from its descending channel (dashed lines). This would mean that the
(DD-) signal is taking effect. Note that the lower boundary of the ascending RSI
channel, which is the validity line for the (DD+) and the upperboundary ofthe descending
channel, which is the validity line for the (DD-), are converging near the 50-level and
forming a potential triangle.
The conclusion ofthis analysis is that a (DD+) in the I S-minute chart points to higher
prices. Expect $56, then check the hourly RSI for a potential invalidation ofthe (DD
) signal. Any possible trouble ahead will be signaled by the I S-minute RSI drop below
its channel. Prices should not drop below Point Q at $51 .30.
56.00
55.SO
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Things move fast in the I S-minute time frame. The RSI violates the tentative (DD+)
reference line at Point R', but the general picture develops as expected. The RSI builds
a (DD+) along the Line Q-R'-S'. The main point is the RSI is still meandering within its
ascending channel. Within this channel, the RSI is on a down-leg inside its sub-channel,
approaching Point S'. Ifthe RSI drops to Point S', the price projection made at Line Q
S will prove to be slightly optimistic. Still, an RSI reversal up from Point S' results in the
fonnation ofa (DD+) signal.
From Point S' the RSI shouldclimb within a rising sub-channel tothe dashed line marked
2, [the upper boundary ofthe larger scale ChanneF (descending) that defines the validity
limit ofthe (DD-) at Points Y'-Z']. If the RSI drops below the channel at Point S', the
(DD+) will be invalidated and the (DD-) will take effect. On the other hand, ifthe RSI
168

breaks out from its descending ChanneF, the (DD-) will be invalidated; hence the
convergenceofthe RSI reference lines at the 50-level. In the pricechart, the contradicting
signals will cause the formation ofa triangle, but the line Q-S is still tentative.
ex·60 ntl NASDAQ Ls52.SIJ ·0.23 -0.•3% 9-52.00 A-56.a7 0-0.00 1'1-0.00 lo-{J.OO C..53.13 Y=O
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Figure 3.44 Hourly LCRX (Chart #5)
It is clear that there is a (DD-) signal at Points X' and Y', while the (DD+) signal is still
valid. In price, this results in a triangle slightly larger than in the I S-minute time frame.
In this chart, the RSI is nowhere near a reference line indicating a reversal up. Will the
upcoming (DD+) signal in the I S-minute chart cause the hourly RSI to reverse up? Or
will the hourly RSI continue down to the nearest dotted line, causing the (DD+) signal to
fail in the I 5-minute time frame? The worst-case scenario would be the latter, with a
price drop to $5 1 .30, [the Lighthouse level ofthe (DD+) in the I S-minute time frame].
Things will become clearer in the first few hours ofthe next trading session, as the 1 5-
minute RSI will show its direction. As discussed earlier, if the I S-minute RSI breaks
down from the ascending channel, prices will likely decline to the lower edge of the
hourly price triangle, around the $5 1 price level.
169

Walter 1. Baeyens
56.50
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Deated wij, T,adeStation
Figure 3.45 LRCX Price and RSI in the I S-Minute Time Frame (Chart #6)
The RSI picture has changed slightly, as a (DD+) signal forms on the lowerboundary of
the ascending channel at Point T', where we had previously anticipated Point S' . Line
Q' -R' -T' moved, but the general picture did not change. Past the (DD+) signal at Point
T', the RSI fails to stay within its ascending sub-channel and even breaks below its
ascending channel. In price, this means that the (DD+) support line Q-T broke. The
RSI break-down means that a new, less ambitious (DD+) signal will probably form.
This happens at Point S'. This (DD+) signal has a lower price target and the price
support line is less steep. In this case, the RSI is signaling that it will leave its ascending
channel and continue down. This becomes clearer at Point U', where the RSI fails to
break out from its descending sub-channel. We have to assume that the RSI is going to
drop back toward Point V', well within bearish territory.
When the RSI drops to the 20-level on November 27th, the rebound causes a (DD-)
signal at Point Y' and the price decline resumes. Will this scenario be repeated? Ifthe
RSI reverses up from Point V', while price stays above $5 1 .30, we will have a (DD+)
signal, but the rebound will lead to the formation ofa (DD-). Look at the RSI tops prior
to Point U', where we have a timid (DD-) signal within a descending sub-channel (not
unlike Point X'). For this picture to turn bullish, we need to see the RSI break out from
its descending sub-channel at a minimum. However, even ifthis happens, there is still
the upper boundary ofthe descending ChanneF to be overcome.
170

Remember, the main question: Is the ascending channel just an up-leg within the
descending Channel2, or is it a new ascending ChanneF? The RSI break-down at Point
S' and the failure at Point U' favor the former scenario, as the down-leg now exceeds
the boundaries ofthe ascending channel. In the price chart, the (DD-) resistance lines
from Points Y and X andthe mostrecent (DD+) support line, define a new triangle. My
conclusion is that ifprice drops belowthe support Line Q-S andthe RSI drops below its
ascending channel, expect price to drop to $5 1 .50.
Also note the width of the channels in this picture. The ChanneF is wider than the
Channel Y' -Z', and both are wider than the sub-Channel Q'-T'.
Rex - 60 min NASDAQ l,.5296 -0.17 ..0 32% B-52.03 A..53.90 0..5279 ti=53.80 Lo=52.o1 C-.:52.96 v=2291657
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Figure 3.46 LRCX Hourly (continued from Figure 3.38)
Here, the (DD-) signal at Points X-Y in the I S-minute chart is valid; the (DD+) signal is
still valid as well. The rectangles in the price and RSI charts correspond to Points V
and V' (respectively) in the I S-minute chart. Note that in this time frame, the target
area is still near the 40-level in the RSI. Ifthe RSI rebounds from this area, the existing
(DD+) signal remains valid. This could mean the RSI will continue up, within a new
ascending ChanneF.
The recent break-down at Point X' was possibly just a minor setback, where the RSI
shifted to a lower gear before starting a new leg up within the larger uptrend. In this
perspective, the descending RSI channel is just a transit phase from one ascending
ChanneF, (which hits its limits in mid-October 2006) to a new ascending ChanneF. If
this is the case, the (DD-) signal at Points X-Y will be invalidated by price rising above
$56 and the RSI will need to break out to the upside from the triangle that is building
171
---------------------------------

Walter 1. Baeyens
between the descending line through Point Y' and the potential ascending ChanneF
lowerboundary.
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Figure 3.47 IS-Minute LRCX (Chart #7 - continued from Figure 3.45)
There are two clear steps down in the RSI chart, each a failed ascending channel.
(These are the pairs oflines labeled 1 and 2). The ascending channel 1 forms high up
in bullish territory, so the break down at Point X only takes the RSI down to a lower
level for a new run within its ascending channel 2. But as we have seen, the RSI has
been unable to escape from the larger-scale descending ChanneF. So far, the latest
ascending channel (2) has only caused the formation of a (DD-) signal inside the
descending ChanneF.
We know where this type of situation leads. If the RSI does not succeed in escaping
from its descendingChanneF,the next stepdown in this RSI cascade (potential ascending
channel 3) is going to take the RSI deeper into bearish territory, with more (DD-)
signals to come. We need to see the hourly RSI break out to the upside from its
descending channel ifthe rally is to resume.
172

X - Daiy NASOAQ L-sJ.13 .0.17 .0.32% 8-52.92 A-S<.10 0-53.08 H-S<.02 Lo-S2£1 C=53.10 V.,667555
35.00
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C,eated with TradeSlabon
Figure 3.48 Oaily LRCX (continued)
Look at the big picture. We notice that price is still well above the (00+) support line.
This fact supports the view that the RSI hasjust taken one step down as a preamble to
a new rally. The fact that the RSI drops below its channel boundary A-B has not
affected the steepness of the corresponding price support line. What we discussed
earlier is the possibility that, after the RSI break-down below Line A-B, Line A-C in the
RSI could now be the lower boundary ofa new ascending channel.
Within this channel, there is a (00+) signal at Point C. The RSI would have to stay
above Line A-C for this scenario to unfold. The fact that the RSI violates the upper
boundary ofits descending ChanneF (circled) supports this view. The arrow symbol in
the RSI chart highlights the point where the RSI reversal down causes a (00-) to form
in the hourly chart. We can conclude that in order to avoid the (00) signal taking
effect, the RSI should not drop below Line A-C. The dashed line through Point A is
now the likely new ascending ChanneF.
From this perspective, the RSI is on a down-leg to the rectangle. But, ifthe RSI stays
above Line A-C-O, after the recent (00+), a bounce to Point B is possible, with price
reaching or exceeding the previous high. A new (OD+) signal will form when the RSI
reverses up from the rectangle area (with prices no lower than $45 at the Lighthouse
level).
173

Walter J. Baeyens
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Figure 3.49 Hourly LRCX (December 12, 2006)
The RSI reverses upward from the projected target rectangle. In price, the decline
stopsjust short ofthe rectangle. In this type ofRSI analysis, it is easier to project RSI
targets than it is to estimate the corresponding price. The rebound ofthe RSI prevents
the (DD-) signal from taking effect and keeps the (DD+) valid. It also indicates that
the RSI is traveling within its ascending channel X'-Y'. Viewed within the larger
ascending ChanneF, this means that the RSI is probably starting its up-leg. There will
be another test when the RSI reaches the upper boundary of the descending channel
around the 60-level, (which it needs, in order to break).
Later, we should see a (DD+) signal appear within this ascending channel X'-Y'. The
conclusion is that the (DD+) signals in the hourly and daily time frames are valid, and
the (DD-) signal in the hourly time frame has not taken effect. We also know that the
RSI has enough room in the daily and hourly time frames for price to reach or exceed
the previous highs. A rally to $56 is expected, when price breaks out from the triangle.
Now, let's check the I 5-minute time frame for any contradicting signals that could
restrict the effect ofthe hourly (DD+).
174

(00+)
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Figure 3.50 I S-Minute LRCX (Chart #8 - continued from Figure 3.47)
Figure 3.50 is the I S-minute LRCX time frame that corresponds to the hourly LRCX
chart in Figure 3.49. The RSI has not reached Point V'. In fact, a mild positive
divergence is building and the RSI already exceeds the 40-level. The only limiting
factor is the apparent RSI Squeeze at the 60-level, along the Line U'-W'. This indicates
that the (DD-) signal can still be taken into account.
So far, the weakness in the market has been unable to push the RSI above the 60-level,
even in the I S-minute time frame! This situation forces us to reconsider the bullish
conclusion that we reached earlier. Namely, in order for the (DD+) signal in the hourly
time frame to take effect, the I S-minute RSI needs to break out of the RSI Squeeze
first. This means that an apparent price break-out will not suffice. The RSI Squeeze
must be broken as well, which will provide an extratool to avoid being fooled by a false
break-out in price.
The RSI needs to break the RSI Squeeze at the 60-leveI before the rally can resume.
This means that the RSI could break out to the upside from its descending ChanneP in
the I S-minute chart. It is important to monitor the RSI behavior around the 60- to 65-
levels, as this will provide an indication about the probability ofthe hourly RSI break-out
ofits descending channel.
175

Walter 1. Baeyens
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Figure 3.5 1 reveals the latest developments in the LRCX I 5-minute chart. The RSI
breaks out above the dotted Line Z'-U' intothe next segment and continues its advance
to the upper boundary ofits descending ChanneF, breaking the RSI Squeeze. Note that
the biggest part ofthe price rise translates in a negative divergence in the RSI. This is
normally a preamble to the formation of a new (DD+) signal because the drop in the
RSI (into the close ofthe session) is markedly out-of-proportion with the drop in price.
It is safe to say that when the RSI reverses up from the rectangle area, another (DD+)
signal will form. Also, given the ascending channel, this potential (DD+) will form
around the 35-level. A rebound from this level will take the RSI into bullish territory
immecliately.
Price breaks from the triangle to the upside, but is stopped at the $54-level. In this case,
the good news is that the RSI Squeeze is broken - the bad news is that the RSI is still
trapped within its descending ChanneF. We anticipate the formation ofa new (DD+),
which should lead to a new break-out attempt in the RSI and a new price test ofthe $54
resistance level.
176

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Figure 3.52 Hourly LRCX (Continued from Figure 3.49)
The hourlychart in Figure 3.49 conflrms the I S-minute picture, as it showsthat the RSI
has not succeeded in escaping from its descending channel. Ifthe scenario in the 1 5-
minute chart unfolds as anticipated, a moderate decline in the hourly RSI will develop
before it reverses up, following the formation ofa (DD+) signal and an attempt to break
out at Point Z'. Since the RSI is trapped in its descending channel, there is a risk that a
new (DD-) signal will form at Point Z', (near the RSI 60-level).
The formation of a (DD+) signal in the I S-minute chart will be important, as it is a
logical step, leading to the possible RSI break-out in the area around Point Z'. This
would also conflrm that the hourly RSI is probably on its up-leg within its potential
Channel X'-Y'. If the I S-minute RSI chart fails to produce a (DD+), the hourly RSI
should drop to the dotted line around the 40-level, while price drops to the $52 area,
[another test ofthe hourly (DD+) support line]. In this scenario, the hourly RSI will get
cornered in a triangle at the 50-level, until it breaks either to the bullish or the bearish
side.
177

Walter 1. Baeyens
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Dealed ""h T,""Stabon
Figure 3.53 1 5-Minute LRCX (Chart # 1 0)
A few days have passed since Figure 3.52, and the yo-yo action in the RSI has pushed
price up high enough to challenge the $54 level. But the RSI never broke from its
descending channel and it continues its course within the narrowing triangle. The
rectangle marks the area where a new (DD+) can be expected to form before the RSI
and price attempt another break-out.
178

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Figure 3.54 LRCX I S-Minute (Chart # 1 1 )
The RSI does not reverse upward from the rectangle area in the previous chart. Instead,
it breaks down from the triangle and reverses upward from a lower (DD+) reference
line S'-T'. Prices takes quite a hit, tumbling from 53.50 to 5 l .50. From Point T', the
RSI could resume its climb within its new ascending channel, but now there are (DD-)
signals at Points X and Y.
A reversal down into Point U' would send price to new lows. Also, ifthe RSI is really
goingto resume its climb, it should beableto break from its descending channel, indicating
that we should monitor the RSI behavior when it approaches the area around Point V',
where a (DD-) signal will likely form. What does this scenario look l ike in the hourly
chart? I refer to Figure 3.55.
179

Walter J. Baeyens
x· 60mNASDAQL-5125-0.04-OJJ8G48-50.55A-56.810-0.00Hi-D.OO lo-O.OO C-S129 V-o
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Crellled IIMh TradeStation
Figure 3.55. Hourly LRCX (continued from Figure 3.52)
The RSI has not reversed up from the rectangular area and has reached the lower
boundary ofits ascending ChanneF, around 30. This is important because it means that
the descending RSI channel Y'-Z' could have been just a transition channel into a new,
lower ascending ChanneF. For this scenario to unfold, the RSI must stay above the
ChanneF boundary. We could accept seeing a W-bottom forming in the RSI, which
might cause slightly lower prices before the RSI takes off. The I S-minute RSI chart
will give us an early warning ifthings go wrong. The significance ofa potential failure
is illustrated in the daily chart in Figure 3.56.
180

• Daly NASOAQ l-50.S1 -0.04 -0.08% e-5O.51 A-50.52 0-50.60 H-SO.74 lo-SO.04 C=50.51 Y-356161
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Figure 3.56 Daily LRCX
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Created Mh T.adeStation
The RSI violates the upper boundary of its descending channel, which signals that it
may have entered the dotted ascending channel. This could save it from entering
bearish territory. The daily RSI reaches the lower boundary of this potential new
channel at the dashed line. This corresponds to the ChanneF in the hourly time frame.
This line is also near the 40-level, which means that a break-down in the hourly RSI will
tell us that the daily RSI is entering bearish territory, staying within its descending channel.
Ifthe daily RSI is to drop to the bottom ofits descending channel at the RSI 30-level, a
price drop to $48 is likely, leaving the (DD+) signal intact.
Given the strong uptrend, we should expect the daily RSI to reverse upward. However,
if it turns out to be unable to break out from its descending sub-channel, new highs in
price will not appear soon. Indeed, as we found in the I S-minute chart, we are likely to
see a (DD-) form first.
181

Walter 1. Baeyens
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Figure 3.57 Hourly EUR/USD (December 1 5, 2006)
Here is another example ofprojecting price targets based on the behavior ofthe RSI.
In mid-November, there are contradicting (00) signals in the RSI, which, in price,
result in thetriangle formationthat is broken to the upside. The explosive price rally and
shallow retracement leads to the formation ofa (00+) signal at Points A-B, within the
ascending RSI channel. As expected, the rally continues, but the RSI is unable to rise
into the next segment within its ascending channel.
Between Points B and C, the RSI drops below the lower boundary and fails to break
out again at Point Y, where a mild (00-) signal is formed. The drop into the bearish
zone at Point C confirms that the RSI is traveling within its descending channel, which
at Points A-B-C still defines the (DO+) signals. However, the (DD+) signal at Points B
and C corresponds to a merely horizontal support line in the price chart, meaning the
rally is flattening out.
As price drops below this Lighthouse level, it is clear that even this support line,
corresponding to the (00+) signal at Points A-C, is too steep. This picture clearly
illustrates how a descending channel in the RSI, when entering bearish territory, often
corresponds to a Head & Shoulders pattern in price. Because the RSI is continuing
down within its descending channel, and taking into account that therewill be no (00+)
signal at Points C-O or even B-O, we can assume that a next (00+) signal will be
formed in reference to Point A.
182

Ifwe consider PointA to be the Lighthouse level for the recent rally, a plausible (DD+)
reference line can be extrapolated in price. Ifprice rebounds from the rectangle, there
will be another (DD+) signal originating in bearish territory. So, this rebound will result
in a (DD-) signal, unless the RSI breaks out from its descending channel. We can
expect a drop to 1 .3000, a weak rebound and a possible (DD-) signal, which will allow
us to define a triangle in price.
183

CHAPTER FOUR
ADDITIONAL THOUGHTS AND TOOLS

PART I
RSI COMBINED WITH OTHER TECHNICAL ANALYSIS TOOLS
It would probably require a large volume to describe all of the interesting analysis
methods that emerge when different technical analysis tools are combined with the
RSL Althoughthe analysis methods described in this book can be used as the main tool,
it would be unwiseto disregard other market information readily available in studies on
moving averages on price, price trendlines, price support and resistance area, price
patterns, volume, Japanese candlesticks, Fibonacci retracement levels, or Elliott Wave
counts.
Nearly all ofthe charts in this book show the RSI graph for the sake ofclarity. However,
when various indicators point in the same direction, there is a higher probability of
success, thus increasing our confidence in trading decisions. Too much analysis may
result in confusion and decision paralysis, especially when various competing analysis
tools are used together. I recommend that the trader emphasize the system that he
knows well, like RSI analysis, using other data to confirm and fine-tune his strategy.
RSI and Price Reference Lines, Moving Averages and Patterns
Generally speaking, whenever a signal is detected in the RSI charts, corresponding
references in the price chart should also exist. If so, they can be used to check the
price behavior and confirm the effect ofthe RSI signal. Thus far in our RSI analysis,
we have used the price support and resistance lines [those that connect (DO) reference
points in the price chart] to determine when (DO) signals are invalidated. We have also
studied triangle and Head & Shoulder formations in priceand corresponding RSI charts.
There are conventional price support and resistance lines, which connect recent lows
or highs or mark price levels ofsignificant lows or highs. These lines can also be used
in reference to the RSL If you believe that price is going to bounce off a horizontal
price support line, (such as a recent break-out level), it may be confirmed by an upward
reversal ofthe RSI, as it reaches the boundary of its channel.
The (DD) Lighthouse levels, which can be used as price support and resistance lines,
will not correspond to the conventional support and resistance levels. This is because,
in an uptrend, the Lighthouse levels originate from a recent higher low, while conventional
support lines originate at a previous top. In a downtrend, the (DD-) Lighthouse level
will correspond to a recent lower high, while a conventional resistance line will mark a
previous price low. Ifyou see price reverse its course in mid-air, with no conventional
support or resistance line in sight, the RSI will often provide the logic behind the price
move. This is especially true when price is moving into uncharted territory at record
highs or lows.

Walter 1. Baeyens
Similarly, ifyou watch price moving averages, it pays to correlate the anticipated price
move with the RSI picture. A (DD) signal will confirm an anticipated price reversal off
ofa moving average line. It will also help determine when the moving average line is
negated. RSI behavior may confirm the significance of price moving average lines
crossing up or down.
RSI and Japanese Candlesticks
There is also a correlation with the Japanese candlestick interpretation. The candlestick
reversal patterns, such as the various Doji formations, Tweezers and Engulfing Patterns,
often coincide with (DD) signals in the RSI. A series of Inside Candles points to the
formation of a triangle in price and RSI and may be clearly visible in smaller time
frames.
Oct
Figure 4.1 Daily SOX
110.00
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7000
6500
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25.00
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Created 'lWh TradeSlation
In this chart, we can closely observe the (DD-) signal formed at Points X-Y in the RSI.
This (DD-) signal appears afterthe RSI drops below its triangle (not shown). At Point
X, price attempts to rally, but is stopped at the dotted resistance line. The next day's
market action results in a (Tweezers) "bearish engulfing" pattern, as price evidently is
unable to rise above resistance and therefore surrenders. A few days later, at Point Y,
the shallow upward retracement causes the formation of a (DD-) signal. A Doji
candlestick warns ofthe imminent downward reversal in price.
188
�------------------------------- ------------------------�----�

SOX(D)- DMy PeT L....76.J9 +0.00 +0 00'l(, e-o.oo "'-0.00 0-0.00 tt-o.OO lo-O.OO Ca476.J9 V-O
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Figure 4.2 Daily SOX (expanded)
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Figure 4.2 shows the (Tweezers) bearish engulfing pattern and the Doji candlestick in
more detail by expanding the circled area from Figure 4. 1 . Interestingly enough, there
is an extra dimension added by correlating various time frames in analyzing candlestick
patterns and the Fibonacci method. The question here is: "In which time frame do I
need to analyze the candlestick patterns to detect the 'real' signals?" This is never
clarified by candlestick followers. Shouldn't there be some kind of "Russian doll"
aspect to the candlestick analysis? Wouldn't it be logical to see a bullish signal in the
daily charts repeated in some way in the hourly (or even in the I S-minute) charts? Not
necessarily! What if the candlestick patterns generated in the hourly chart contradict
the signals generated in the daily chart?
189

Walter J. Baeyens
Figure 4.3 Daily Russell 2000 Index
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In the second week ofJune, there is a Doji-like candlestick (at the arrow), about halfway
down on the second leg. This type ofcandlestick, with its long shadoworwick, normally
indicates that the price decline may be over, because price has managed to recover
nearly all ofits intraday losses. This is a sign ofstrength. Since the RSI calculation is
based on closing price, this giant yo-yo move, ending with a nearly flat close, does not
even register in the daily RSI. But it does show in the hourly chart! Apattern that could
be considered a bullish candlestick signal, (orjust a neutral price behavior, with the daily
RSI moving sideways), turns out to be quite a different picture in the hourly chart.
190

Averages 0 75.82
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Figure 4.4 Hourly Russell 2000
6r16 6119 6f20 6121
The arrow indicates where the intraday price reversal upward occurs. There is a clear
Doji candlestickhere as well. The yo-yo price action is clearly visible, as it takes several
hours to complete. Contrary to the daily chart, the hourly picture has a series ofbearish
pricemoves,which affect the RSI calculation as well as the formation ofthe candlesticks.
In fact, in the hourly Russell chart, the intraday price rebound causes the formation ofa
(DD-) signal, followed by a price drop to its projected target.
In reality, what could be interpreted as a bullish candlestick signal corresponds to a
shallow price retracement up in a bear market. The conclusion is that the Doji candlestick
in the daily chart is just a coincidence. The price rebound that caused it happened to
start at exactly the right moment. What would the daily candle have looked like had the
price rebound started two hours later? The hourly chart tells a better story!
191

Walter 1. Baeyens
RSf and Fibonacci Retracement
Several books have been written about the use of Fibonacci retracement ratios and
how to project future price activity based upon these ratios. In general, if a trend is
strong, the occasional counter-trend moves will be shallow. In a weakening trend, the
counter-trend moves will become deeper. As a general rule, retracements of less than
38% of the latest price move indicate that the existing trend is still "very strong."
Corrections ofup to 50% ofthe latest price move indicate a "strong" trend. Counter
trend moves of60% to 75% indicate a "weakening" trend and any retracement ofover
75% signals a potentially "failing" trend. If price retraces over 1 00% ofthe last price
move, it provides an indication that the largertrend may be reversing. Indirectly, this is
basically what is used to detect (DD) signals and determine their projected price targets.
In the RSI picture, a retracement is deemed shallow when it causes a (DD) signal; it is
assumed that the correction is over and that the trend will resume. The price target
calculation method does not take into account the retracement percentage as an
indication of the strength of the (DD) signal.
This leads me to the conclusion that the method ofprice target calculation here is not
very sophisticated. I do not consider the (DD) price targets as truly accurate price
objectives. Rather, I think ofthese targets as indicative ofthe magnitude and direction
ofthe forces pulling on the trend (vectors). In my view, the adverse effects ofa missed
target should not be overstated. The next (DD) signal may hit (or even exceed) its
target.
192

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Figure 4.5 Hourly CVD
Figure 4.5 illustrates how Fibonacci retracements can be correlated with RSI signals.
After a severe drop (note the RSI break-down from the triangle), prices recovered
50% of their losses, hinting at a further drop of about the same size. However, we
notice that the RSI fails to drop below its ascending channel and a modest (DD+) signal
appears. Anothertriangle seems to be forming in the RSI. Which way will it break this
time?
The equivalent ofTime Frame Correlation in the Fibonacci method is the use ofclusters
of support and resistance lines. The clusters mark the area on the price chart where a
significant confluence of mUltiple Fibonacci ratio reference lines are present. These
ratio lines are plotted using several main and intermediate price pivot points, as a
reference, in various time frames. This adds some depth to the analysis.
One ofthe gray areas in Fibonacci analysis occurs when we attempt to interpret price
retracements exceeding 1 00% ofthe reference price range. In such cases, look at the
retracement ratio in reference to the bigger picture using other reference points. Now
the question is: "Which reference point should we use?" There will be several minor
and major price pivot points to choose from. Another question will be "Do we use the
price extremes as references? Or do we use the closing price for that time frame?"
Ifyou elect to use closing price, the Fibonacci picture will vary with the analysis ofeach
time frame, although the underlying retracements will be relatively identical. It would
be an interesting exercise to test the Fibonacci method using the price reference points
that correspond with RSI signal reference points. These points do not always coincide
193

Walter 1. Baeyens
with obvious price lows or highs that we would otherwise use. Also, this would increase
the chances of feeding significant price reference points into the Fibonacci grid.
)8�
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Figure 4.6 Daily Crude Oil Futures
In this uptrend, there is a downward price retracement from Point A. In an attempt to
define a price reversal point, the Fibonacci grid is plotted using Points Z andA as anchor
points. In this example, the price line is based on daily closing prices. After a brief
rebound from Point B, the price decline resumes into Point C, exceeding the 100%
mark of the reference price advance from Points A to Z. Assuming the uptrend is
intact, we can see the price decline from Point A to C in the bigger picture.
Using the earlier price low at Point Y as a reference (ratherthan Point Z), we find that
price level C is a 76.40% retracement of the price advance from Point Y to A. This
means that the price retracement from Point A to C is relatively shallow and the price
rally from Point C will probablyreach new highs.
As I am not a Fibonacci expert, I am not sure why Point Y is chosen as the reference
point and not Point X or earlier price lows. This takes us back to an earlier discussion
when the significance offailing (DD) signals was examined. The question is: "How
far back do you regress when studying price retracements exceeding 100% of the
initial reference price change? When do you decide that the trend has changed instead?"
In Figure 4.6, the Fibonacci retracement using Points Y and A as reference points
seems to make more sense. In this new Fibonacci grid, Point C corresponds to a
76.40% retracement, while at Point B, price rebounds off the 50% retracement line.
What does this look like in the RSI chart?
194

Figure 4.7 Daily Crude Oil Futures
Figure 4.7 covers a slightly larger time period of the daily crude oil futures data and
includes the RSI chart. The Fibonacci retracement lines are plotted in reference to
Points Y and A, but the lines have been extended to the left for a better readability ofthe
percentage figures. In the RSI chart, there is a (DD+) reference line W'-X'-Y'-C'. In
price, the corresponding price support line is a significant reference line. Looking at the
(DD+) signal at Points X' and Y', we can determine the lower boundary Y'-Z' (dashed
line) ofthe associated ascending ChanneF.
The arrow symbol marks the point where the RSI breaks below this ChanneF. In this
respect, it looks like the RSI drops to Point B' and Point C' within the descending
channel W'-C, signaling the transition of the RSI from one ascending ChanneF to a
new ascending ChanneF, starting at a lower level. But the price drop to Point B is deep
enough to cause the formation ofa (DD-) signal in the RSI chart.
At the same time, there is a (DD+) signal at Points Z' and B'. This casts a different
light on the Fibonacci picture, telling us that the price retracement to Point B is shallow
and a rally should expected, (this will take prices higher by 80% to 1 00% ofthe previous
price rise from Point Y to A).
The conflicting (DD) signals allow us to define a triangle in the price chart. When price
breaks below the triangle support line Z-B, and below the 50% retracement line, we
know that the (DD-) signal is taking effect, invalidating the (DD+) signal as price drops
195

Walter 1. Baeyens
below price Lighthouse level Z. The drop to Point C is deep and the subsequent rebound
leads to the formation ofanother (DD-) signal.
These (DD-) signals' reference lines define the upper boundary ofan ascending sub
channel that takes the RSI above the 40-level. These (DD-) signals are eventually
invalidated as price rises above the $5 1 Lighthouse level. In the price chart, this
invalidation corresponds to price negating the formation ofa potentialright shoulder at
the $50 level.
Contrary to the Fibonacci signal at Point B and Point C, the RSI warns us that a
resumption ofthe rally is not so obvious. Had the second (DD-) signal past Point C'
taken effect at the end ofJanuary 2005, price would have broken the support line in the
vicinity ofPoint D. Therefore, a drop to the $36 level, [the (DD+) Lighthouse level],
would have been more likely.
RSI and Elliott Wave Analysis
I am convinced that a combination of these analysis methods will lead to excellent
results. Because I am not an Elliott Wave expert, I am not in a position to test the RSII
Elliott Wave correlation with confidence. But it is clear to me that the Elliott Wave
count is a useful hypothetical framework within which the RSI analysis can be applied.
One should exercise caution, as non-experts can easily misinterpret Elliott Wave counts.
It is necessary to observe large numbers ofparameters in different time frames in order
to arrive at a plausible high probability Elliott Wave count. In other words, for non
experts, there is plenty ofroom for error. Still, ifyou have access to expert Elliott Wave
data, you may find it useful to confirm the results of your RSI analysis within the
framework ofa high probability Elliott Wave hypothesis. For best results, make sure
both studies cover similar time frames.
196

spx.x(OJ -_ CBOE L-139948 .12.16 <lJS� B-1J98.18 A.1399.15 0>1386.94 �1401 1 4 L...1386.94 C-1399.48 V-o
Figure 4.8 Weekly S&P 500 Index
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Ifwe consider the rally ofthe past four years to be a 5-wave "impulse advance," then
the first four waves could possibly be labeled as shown in Figure 4.8. There has to be
a correlation between the different Elliott Wave impulses and the signals generated in
the RSI. At the start ofa 5-wave rally, isn't it likely that the RSI should advance into
bullish territory, thus invalidating an earlier (DD-) signal and indicating a potential trend
reversal? At the start ofWave 3 up (the major up-wave ofthe pattern), wouldn't it be
logical, or even mandatory, to find a (DD+) signal?
As Wave 3 (up) develops, we would expect to see a series of(DD+) signals developing
within an ascending channel, confirming the uptrend. Wave 4 (down) could likely be
anticipated by the appearance of a (DD-) signal in the smaller time frame. The
resumption ofthe uptrend in Wave 5 should be marked by another (DD+) signal. After
the completion offinal Wave 5 (up), Elliott Wave theory says that a retracement down
should be expected to the area of the previous Wave 4. In the RSI, this typically
corresponds to the RSI break below its ChanneF after a negative divergence. This is
the scenario that unfolds in the SPX chart ofFigure 4.8.
197

Walter 1. Baeyens
PART II
PRACTICAL GUIDELINES: PLOTTING RSI CHANNELS
Starting from Scratch
Starting from abare price/RSI chart, what is the best way to detectand plot the relevant
RSI channels? Here are some practical guidelines and hints. First of all, we need to
make sure that the RSI settings are correct: 14 periods, based on closing prices. It is
also important that sufficient data is available for a correct RSI calculation. When
analyzing futurescharts, we may f
mdthatthe available pricehistory is tooshort, providing
insufficient data to produce reliable RSI calculations in the larger time frames.
A· Deity NASDAQ l-36.21 +0.00 +000% 8-3622 A,-36.30 ()toQ.OO Hi-O.OO lo-O.OO C-36.21 v-o
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Figure 4.9 Daily NVDA
When working with charts, be sure that the analysis features are clearly visible. In
Figure 4.9, the RSI plot strip is not wide enough, resulting in a flat and featureless RSI
landscape. The RSI chart needs to be bigger in relation to the price chart.
It is also important to display the RSI history within a 0 to 100 range, thus avoiding
misinterpretation ofthe RSI level. Ifthe RSI range is set from 30 to1 00, the eye will
interpret the RSI at 50 (when it is halfway between the bottom and top ofthe chart). In
reality, the RSI is at 65. The difference is huge! The chart needs to be compressed
along the time axis, which will help in detecting previous channels from which we can
build up the actual RSI picture.
198

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Figure 4. 1 0 is a better set-up. The RSI chart covers more than a third ofthe total image
and about three and a halfyears ofdata has been compressed into the image. What do
we see in this chart? The market is flat to bearish with the RSI value around 20 until
July 2004, when we see the start of a bull market all the way to the present day. So
after July 2004, we should be able to find a (00+) signal anddefine an ascending RSI
channel.
199

Walter J. Baeyens
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Figure 4.11 pinpoints the trend reversal from bearish to bullish in the price chart and
there is a clear (DD+) signal in April of2005. The low point ofthe (DD+) signal in the
RSI is the reference point for an ascending channel, which runs all the way to May of
2006, when the RSI breaks down at Point X.
The upper boundary of the ascending channel is not well defined in this chart. Let's
consider the crossing point ofthe moving averages to be the starting point. A sizeable
price correction to the downside follows, but the uptrend appears to remain intact. Still,
the RSI drops to the 20-level in June 2006 before a positive divergence pushes the RSI
back above 40 in August 2006.
If the uptrend remains intact, we can consider the RSI drop at Point X to be a shift
down into a new ascending channel, starting from a lower level. This allows us to
define the lower boundary ofa potential new ascending channel, (the lower line running
parallel to the main channel). But the drop is so deep that the RSI enters bearish
territory and, consequently, there may be a (DD-) signal within the last few months.
200

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Figure 4. 1 2 depicts another interpretation of what we learned earlier. If the upper
boundary ofthepotential ascending channel originating at PointA is def
med by drawing
a parallel line, a (DD-) signal forms in September of 2006. Whenever we find a
(DD-) signal, we need to define a descending RSI channel within which a series of
(DD-) signals may develop, ifthe trend change is confirmed. When this line is plotted,
it becomes clearthat this reference is significant because it def
mes a negative divergence
that has its origins in 2005.
Looking at this, we can determine that a negative divergence has taken the RSI so far
down that a first (DD-) signal forms within the descending channel. The upper boundary
ofthe descending channel is a plausible reference line because its parallel lowerboundary
connects two RSI lows. This puts its origin at the crossing point ofthe moving averages
in August 2005. This channel boundary, up to Point A, defines two important (DD+)
signals, which means that there were conflicting valid (DD+) and (DD-) signals in
October2006.
Conflicting signals in the same time frame indicate thatthe market is in a phase where
bullish and bearish forces are in balance, which may lead to a trend change. At this
stage, we might want to check the bigger picture in the weekly time frame. The
triangle in the price chart illustrates the bull vs. bear fight, which is ultimately won by the
bulls.
201

Walter 1. Baeyens
This chart provides a close-up illustration of(relatively) one year ofdata with reliable
reference lines, anchored on solid reference points in the past. This picture is not
straightforward. The RSI could be moving either within its descending channel, as the
negative divergence has not been broken, or within its ascending channel, following the
(DD+) signal at PointA. Consequently, we have two RSI reference lines, one ascending
and the other descending, clearly converging symmetrically toward the RSI 50-level.
202

RSJ: Logic, Signals & TIme Frame Correlation
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Figure 4.14 NVDA Daily Price and RSI(3)
At this point, we could look atthe RSI(3) chart, which only covers three periods ofdata.
This near-tenn RSI study often provides us with rough, easy-to-recognize references
that can help illustrate a more detailed RSI(1 4) picture. The line in the RSI(3) chart is
not the RSI itself, but the much smoother 3-period moving average ofthe RSI(3).
We find traces ofa (DD-) signal in June/July of2006, where the RSI bottoms below 20
in bearish territory, and is followed by a positive divergence. In October and December
of 2006, there is a (DD+) signal; it is incomplete, which allows us to plot the lower
boundary of an ascending channel. In the price chart, the two (DD+) support lines
coincide. This study confinns what we found earlier. In this chart, the negative
divergence is significant, resulting in a triangle building on either side ofthe RSI 50-
level. What do these (DD+) signals look like in the RSI( 1 4) chart? Figure 4. 1 5 shows
theresult:
203

Walter 1. Baeyens
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Now, it is time to find out how this translates into the hourly RSI picture. Let's switch
to the hourly time frame, starting with a suitably compressed hourly chart.
204

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Figure 4.16 Hourly NVDA
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The (DD+) signal that appears at Point B can be easily spotted in the daily chart. This
provides us with a baseto complete the RSI picture. The associated ascending channel
connects the recent RSI lows.
205

Walter J. Baeyens
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Figure 4.17 NVDA Hourly
The dashed parallel line defines the upper boundary ofthe ascending channel, within
which the recent (DD+) signals have been building. Now, it becomes obvious that the
RSI has been drifting toward the bottom ofthis channel in the last few weeks, due to a
severe negative divergence, which brings us to the next picture.
206

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If a line is plotted parallel to the negative divergence reference line, we are able to
define a descending channel. This is a familiarpicture. There is the ascending channel
defining the bullish elements, [the (DD+) signals], and the descending channel defining
the bearish element, (the negative divergence). This results in converging reference
lines. In this case, the RSI appears to be zeroing in on the 50-level as the bull vs. bear
fight continues.
207

Walter 1. 8aeyens
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Since we have detected solid reference points, we can now zoom in on the hourly chart
and examine the recent RSI history. (The channels just defined are labeled l and 2).
The RSI is meandering within the overlapping area, while price has broken the (DD+)
support line and is moving sideways.
208

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Ifthe last few days of RSI and price data are viewed closer, we can see that there are
conflicting RSI signals whose reference lines define an even more acute RSI triangle,
within the converging channels. The RSI is cornered at the 50-level. The triangle
becomes visible in the price chart as well. A breakout either way is to be expected.
The larger picture is bullish. If the hourly RSI breaks out to the upside, it will need to
overcome the negative divergence to continue its rally. Ifthe RSI breaks the triangle to
the downside, we can expect the formation of another, more modest (DD+) signal
within the ascending channel. However, should the RSI drop below its ascending channel,
entering bearish territory, we will see an acceleration ofthe price correction downward.
If this were correlated with the daily picture, it would mean that the daily RSI would
start its down-leg to the lower boundary ofits ascending channel, where a new (DD+)
could be formed at Point C.
Point C is situated around 30 in the daily chart; as the Lighthouse price level for a
(DD+) signal at Point C is $28.30, the price drop in this scenario could be considerable!
When will we know that this scenario is not unfolding? When the hourly RSI breaks
out to the upside and breaks the negative divergence. This would mean that the daily
RSI is reversing up from the 54-level, taking price to new highs (as it has headroom to
rise all the way to the 70-level, which is the upper boundary ofits ascending channel).
209

· SO "*' NASDAQ l037.'9 .0.64 '1 .7'% B-37.4D A-37.64 0-37.09 flo37.50 l0-36.86 C-37.50 V-12508786
1004 10AJ9 10112 10116 1011 9 10/2' 10/26 10131 11m 1 1 03 1MO 11M 11120 11/22 1 1 129 1201 12.116 1 2111 12113 12118 12121
c..dIed """ T,adeSl"""
Figure 4_2 1 Hourly NVDA
This hourly chart shows the next stage in the NVDA story. The RSI breaks out from its
triangle to the upside and reaches the negative divergence reference line. As the RSI
break-out is to the upside, it looks like the ascending channel is nowquite significant, so
we can highlight it in the chart. Still, we also need to see the RSI break the negative
divergence because that will mean that the daily RSI is not starting its down-legjust yet.

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Now, let's take another look at the daily NVDA chart in Figure 4.22. Following the
recent reversal up (the break-out in the hourly RSI), the RSI has reached Line Z-D,
which defines a severe negative divergence. This could be considered a down-leg
(descending sub-channel) that takes the RSI down to Point C. Ifthe RSI manages to
break-out at Point D, it will have headroom to rise to the 70-level, where it will face the
even larger long-term negative divergence.
This would mean that the negative divergence along the Line Z-D has not pushed the
RSI into bearish territory, but has merely caused the formation ofa (DD+) signal while
price has kept rising. An RSI breakout at Point D will see price rally in an explosive
way as the RSI rises into the next segment. This RSI break-out, ifit materializes, will
first be clearly visible in the hourly chart.

Recap: Plotting RSI Channels
RSI channel boundaries are defined by:
Lines running through (DD-) or (DD+) signal reference points
Price/RSI divergence reference lines
Lines connecting obvious RSI extremities
Lines running parallel to the abovementioned
Lines running parallel to channels established previously
Ifin doubt about which ofthe candidate channel reference lines to use:
Check the other time frames for corresponding channel reference points
Check the RSI(3) chart for obvious (DD) reference points and transfer those
to the RSI( 1 4) picture
Give preference to the line whose parallel defines a meaningful channel boundary
on the opposite side
Use the reference line that originates on or closest to the crossing point ofthe
9-period simple moving average (SMA) and 45-period exponential moving
average (EMA) lines in the RSI
If one ofthe candidate lines is symmetrically converging (in reference to the
RSI 50-level) with an earlier, well anchored reference line ofan opposing RSI
channel (ofthe same size), then this reference line is to be given preference
Horizontal channels are not an option
Anytime a descending channel is defined by connecting two (DD+) reference points in
the RSI, an ascending ChanneF should be plotted as well, whose lowerboundary is the
signal's "validity line," running through the most recent (DD+) reference point. The
typically bullish picture is a series of (DD+) segments or channels inside an ascending
ChanneF.
Anytime the ascending channel is defined by connecting two (DD-) reference points in
the RSI, a descending ChanneF should be plotted as well. The upper boundary is the
signal's validity line, running through the most recent(DD-) reference point. The typically
bearish picture is a series of(DD-) segments or channels inside a descending ChanneF.
When the RSI is moving within an unusually narrow range, (that is markedly steeper
than the established channels or ChanneF), assume that the RSI is moving within a
temporary sub-channel that will be broken as the RSI returns to normal channel
boundaries.

CHAPTER FIVE
REAL-TIMEAPPLICATION

PART I
DRUG INDEX ($DRGX)
Beginning January 4, 2007, we track a stock sector index that is not as clearly bullish as
the main indices, such as Dow 30, S&P 500, NASDAQ, SOX and XOI. [I selected the
DRG Index (pharmaceuticals) because it has been in a consolidation phase for quite
some time). In this case study, we want to begin with naked charts and practice
identifying RSI signals, plotting the RSI channels andcorrelatingthe signals in different
time frames. This method should allow us to formulate a probable scenario for the near
future. Let's start with the big picture in the weekly time frame.
.x. Weekly AAEX L-352.34 +01)1 +o.cw::r-.4 B-352.17 "'-352.49 0-0.00 H-OlXl lo-O.OO C-352.33 V-O
Figure 5.1 Weekly DRG
440.00
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300.00
280.00
260.00
100.00
90.00
00.00
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3000
20.00
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In Figure 5. 1 , we should first make sure that enough data is available for a correct RSI
calculation. We should also compress the picture in order to make the RSI features
clearly visible on the chart. In mid-2002, there is a price rebound after a deep decline.
From 2003 to the end ofthe chart, price moves sideways, onto "slightly higher."

Walter 1. Baeyens
1998 1999
(00+)
.4000
420.00
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260.00
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100.00
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Figure 5.2 shows the RSI scenario leading to the steep market drop in 2002. The
market trend is up, but the RSI is traveling in a descending channel, showing negative
divergence. The lower boundary ofthis channel is anchored on (DD+) signals. 200 I is
characterized by an RSI Squeeze at a value of 54, (hardly a typical level of a bull
market!). At Point X, the RSI surrenders, dropping below the lower boundary of its
ascending ChanneF, cascading deep into bearish territory. This is the type ofscenario
that leads to an RSI range-shift from the bullish range, between 40 and 80, to bearish,
between 20 and 60.
216

SORQ)(- Weekly AMEX L-352.34 +0.01 +O.IXl'% B-352.17 A·J5249 0-0.00 tt-O.oo lo-O.OO C-352.33 V-O
The rebound at PointA forms a (DD+) signal, but its origin lies deep in bearish territory.
Consequently, the formation ofa (DD-) signal is expected. The ascending RSI channel,
starting at Point A', is defined by a (DD-) signal at its upper boundary. In 2003, it
becomes apparentthatthe range-shift in the RSI is not materializing, as the RSI manages
to reach 70. The RSI reversal upward at Point C' confirms that the RSI is continuing its
course in its ascending channel. A (DD+) signal appears within this channel at Point
C'. The LineA'-C' defines the limit ofthe validity ofthis signal. In 2005 and 2006, the
RSI advances within this channel, exceeding the 40-1evel.
217

Walter 1. Baeyens
400.00
380.00
360.00
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320.00
300.00
51Aver�s 0 56.58 100.00
_
_
-
-
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Figure 5.4 Weekly DRG (continued)
There is a (DD+) signal at Points B' and C', but the price action following this signal is
certainly less than convincing. At Point Z', the RSI fails tojump into thenext segment,
resulting in a (DD-) signal at Points Y'-Z' . At Point E', the RSI reverses upward from
the channel bottom, while staying above 40. There is a (DD+) signal at Points D' and
E'.
These conflicting signals are typical of an indecisive market. In the price chart, the
support and resistance lines D-E and Y-Z define a triangle. In the RSI, a triangle is
detected as well, centered on 50. The arrow marks the point where the RSI breaks out
from this triangle. The RSI is apparently making its way into the next segment after all.
Conclusion: After a transition phase, the weekly picture is turning bullish. The RSI
needs to stay above LineA'-C'-E'; the (DD-) with the Lighthouse resistance level is at
400.
218

$ORO)(- Daly AMEX l-35234 +0.01 +0.00% 8-352.17 ,6.-352.49 0-0.00 ti-O.ooLo-O.OO C-352.33 v-o
Figure 5.5 Daily DRG
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340.00
330.00
320.00
310.00
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2000
1000
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Figure 5.5 is a naked daily DRG chart covering data from the last three years. The
weekly chart provides clues as to where the (DD) signals, in this daily chart, should be
found. There is a price low in October 2004. From that point on, prices rally.
219

Walter 1. Baeyens
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Figure 5.6 shows the ascending RSI channel, which is defined by a (DD-) signal at the
top of the channel and severe positive divergence defining its lower edge for most of
2004. In 2005, a first (DD+) appears. The conflicting (DD) signals define a price
triangle. As the RSI stays within its ascending channel, the (DD-) signal does not take
effect and another (DD+) forms in April 2006.
The most recent signal is a (DD+) signal at PointsA' and B' with a price target of383.
The corresponding support line in the price chart is extremely steep. Point Q marks the
point where price has broken above the (DD-) Lighthouse level, which is now a support
level. We should note that the RSI violates the channel bottom at Point B'; this may
indicate that the RSI is on the verge of starting a descending channel. This is not
unlikely, as there is a negative divergence already building.
Conclusion: The daily picture is bullish, as there are consecutive (DD+) signals within
an ascending channel. Strong price support exists at 340. However, the RSI mustjump
into the next segment soon. If this fails, the RSI may form a descending channel, [the
formation ofa new (DD+) signal with a less ambitious price support line]. This scenario
indicates that price may drop to the 340-level before resuming the rally to new highs;
both weeklyand daily vectors point higher.
220

)(. DoIy A>El< L.352.34 >0.01 >0.00% 8-352 1 7 A03S2.'9 0-0.00 �O.OO LooO.oo C·352.33 V-O
360.00
355.00
3<5.00
3<0.00
335.00
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Figure 5.7 Daily DRG with 3-day simple moving average ofRSI(3)
Let's tum to the RSI(3) for a quick cross-check. Here, the ascending channel can be
seen with consecutive (DD+) signals. The only negative element is that the RSI(3)
fails to exceed 80 within the last two months. This confirms ourearlier concerns about
the negative divergence. It is possible for the RSI to drop to the 20-level before a new
attempt at breaking above the 80-level.
221

Walter 1. Baeyens
$ORO.x · 60 m AhEX L-352.34 +O.Q1 +0.00% 6aJ52.17 ....352,.9 0-0.00 �.OO Lo-O.OO C-352.33 V-o
360.00
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Figure 5.8 Hourly DRG
Now, we can tum our attention to the hourly time frame. The RSI generally meanders
in the range of 20 to 80, but in the last few weeks the value manages to maintain at
above 40. The (DD+) signal is still valid; it coincides with the most recent signal in the
daily chart. This (DD+) signal defines the lower boundary of a descending channel
while a negative divergence defines its upper boundary. We now have a close-up
picture of what should be monitored: the break-out of the RSI from the negative
divergence. Apparently, the RSI has chosen to go up within its new ascending channel;
this channel also features a (DD-) signal.
We need to see a more convincing RSI break-out before we can conclude that the RSI
is breaking out ofthe triangle to the upside. A logical RSI move would be a drop to the
lower boundary of the ascending channel first, where a reversal up would cause the
formation ofa (DD+) signal ifprice remains above 345. This is the preferred scenario.
Conclusion: The daily and weekly vectors point up. Expect price to drop to the 340-
345 area before it continues its advance. This scenario will become invalid when the
hourly RSI breaks below its ascending channel. Ifthe hourly (DD+) signal is invalidated,
we may see a price drop to the (DD+) Lighthouse around 330. In other words, if the
hourly RSI does not succeed in breaking out to the upside, it will stay within its descending
channel. Ifthis happens, it will eventually drop into bearish territory. In the price chart,
this typically results in the formation of a Head & Shoulders pattern. The (DD-)
Lighthouse level at 357 may be theupperprice level for the right-hand shoulder, (which
may now be building). Given the main uptrend, our strategy should be to look for an
opportunity to go long when price rebounds from 345 and a (DD+) signal is created in
the hourly time frame.
222

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Figure 5.9 Hourly DRG (January 5, 2007)
Price has declined modestly andthe RSI has dropped back fromthetop ofits descending
channel. I have lowered the RSI reference line X-Y; this is a line from which the RSI
has been reversing in the recent past. Also, Line X-Y defines a (DD-) signal.
As the hourly RSI fails to break out from its descending channel, the RSI forms a
(DD-) signal within a descending channel; a bearish scenario. On the other hand, the
(DD+) signal is still valid. This allows us to define a triangle in the price chart. Note
that the (DD-) signal forms at 75, which is a relatively high RSI level. This means that
the next RSI drop should logically lead to the formation ofa (DD+) signal within the
ascending channel at the 35-level. Conclusion: The preferred scenario still stands.
Expect a price drop to the lower edge of the price triangle. A price rebound should
cause the formation of an hourly (DD+) signal. How does this translate in the daily
DRG chart?
223

Walter 1. Baeyens
.X . Daiy ME)( l-3S0DB -2.25 -0.64% B-349.76 "'-351).31 0-352.34 ti-3S2.53 Lo-348.9S C-350.re v..a
360 00
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The downward RSI reversal at Point Y' makes it clear that the RSI may travel within
the descending channel defined by the (DD+) reference line A'-B'. Reference line X'
Y' also defines a (DD-) signal in the daily time frame. It should be noted that Point Y'
is near the 65-level. The reference lines ofthe conflicting (DD) signals result in price
triangle. For now, we can consider the new RSI Channel X'-Y' to be a steep sub
channel, corresponding to the ascending channel discussed in the hourly DRG chart.
Another interesting point is that the RSI moving averages cross to the upside, which
could provide support for the RSI. Conclusion: The preferred scenario stands. The
RSI is expected to drop to its 9-day moving average before reversing up. However, the
RSI must stay within its ascending sub-channel ifthe rally is to continue. We expect a
further price drop with a rebound off ofthe lower edge ofthe triangle. Ifthis causes
the formation ofa (DD+) signal in the hourly time frame, we may consider taking a long
position in DRG.
224

,X - DMy AMEX L-347.59 ·0.03 -0.01% 8-34738 A.34774 0-000 1-1-0.00 LozO.OO C..347.62 V-o
(00+)
Figure 5.11 Daily DRG (January 8, 2007)
A
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The DRG closing price is lower, but is far from the lows of the day. The RSI reaches
the crossing point ofits moving averages and may find support at this level.
225

Walter J. Baeyens
36000
(DO.)
355.00
350.00
345.00
340.00
335.00
330.00
325 00
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Figure 5.12 Hourly DRG
This is the price rebound toward the end ofthe trading session. The RSI bounces off
the potential (DD+) reference line, but the signal is not complete at this point. A signal
would be more solid ifit were to form on or near the lower boundary ofthe ascending
channel. Expect price to move sideways-to-up, while the RSI completes the (DD+)
signal near the lower edge ofits ascending channel.
226

.x. 60 ITWl AhEX LaJ50.37 +0.01 +O.())<Jt 6-350.18 ....350.57 �.OO 1-1-0.00 Lo-O.OO C-350.36 V-o
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3040.00
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Figure 5.13 Hourly DRG (January 1 1 , 2007)
After some minor up/down moves, the RSI pops up. This activity is compatible with
our anticipated scenario, [the formation of a (00+) signal on the potential (00+)
reference line in the RSI].
227

Walter J. Baeyens
.x · Daiy AMEX L-3S0.37 +0.01 +0.00% 8-350.18 A-350.S7 0-0.00 IiooOOO lo-O.oo (,350.36 V-O
360.00
355.00
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335.00
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31000
100.00
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Figure 5.14 Daily DRG (January 1 1 , 2007)
In Figure 5.14, the RSI finds support on the moving averages and reverses to the
upside. From here, we could expect the RSI to rise to the top ofits (potential) descending
channel, thus defining a severe negative price/RSI divergence. Will the RSI be able to
break this divergence? In order to do so, another (DD+) signal in the hourly chart is
required.
228

(DO.) lighthouse
3<5.00
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330.00
325.00
7126 em 8110 8117 8J25 9.()1 9111 9118 9126 1003 10110 10118 10125 1 1 .(11 11.Q8 11116 11124 1 204 1 2111 12118 1 2127 1ai 1112 '122
Figure 5.1 5 Hourly DRG (January 1 8, 2007)
We expectthe RSI to drop to Point Z, where a (DD+) signal should form. Instead, the
RSI continues up andbreaks out from its descending channel, signaling that the ascending
channel, (defined by Line X-Y) is in force. This will mean that a future (DD+) signal at
Point Z, when it materializes, will form near 40 in an ascending channel, making the
picture quite bullish.
The RSI channel top X-Y still defines a (DD-) signal, but the RSI is reaching 80 and a
(DD+) signal is forming. Price breaks the triangle to the upside and reaches the
(DD-) Lighthouse level at 357. Assuming that a (DD+) will form at Point Z, we know
that price will not be lower than 342, the Lighthouse level ofthe (DD+). This means we
could have taken a long position in DRG, when price broke the triangle at 353. However,
it is safer to wait until price breaks the (DD-) Lighthouse level.
229

Walter J. Baeyens
Figure 5.16 Daily DRG (January 1 8, 2007)
The RSI rebounds off the 9-day simple moving average and reaches the top of the
ascending sub-channel X'-Y', violating the upper boundary ofits potential descending
channel. Note that the daily RSI is now well within bullish territory.
230

(00-) lighthouse
335.00
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Price rallies above the (DD-) Lighthouse level intraday. A long position is entered at
357. The RSI pushes the top ofits ascending channel around the 85-level. The embryonic
(DD+) signal allows us to define a support line in the price chart. We know that the
rally is safe, as long as the RSI remains within its ascending channel. The RSI will form
the (DD+) signal at Point Z with price near the price support line (in the 352 area). For
now, let's place the stop-loss order at 349.
231

Walter J. Baeyens
7125 7131 6A'JI3 6115 am 81lJ 9AJ7 9114 9/21 9129 10.os 1M3 10123 10.00 11.03 11113 1 1 121 11129 12.07 12/14 12121 1ID 1110 1118 1125 17:])
( !Jill]
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Figure 5.18 DRG Hourly (January 23, 2007)
Intraday prices nearly reach the previous high at 362, before retracing down. Look at
the effect this minor price move has on the RSI. From Point W, where the RSI is near
90, the RSI drops to 52. At this rate, the RSI can be expected to reach Point Z with
price around 355. The important point is that the formation of a new (DD+) signal
becomes more likely each hour. More importantly, if this scenario is to become a
reality, the RSI must reverse upward at Point Z.
232

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The mild price retracement down extends, causing the RSI to reach the (DD+) reference
line (where it reverses up). Price does not break below the Lighthouse level at 356.
This resistance level offers support. The (DD+) signal is almost conftrmed, but the RSI
may still drop to the lower boundary of its ascending channel at Point Z'. The long
position is maintained, with the stop-loss orderresting at 349, as long as the RSI remains
within its ascending channel.
233

Walter J. Baeyens
X - Deit AMEX l-357.42 +0.00 +OOO'l. 6-357.22 A-3'5765 0-0.00 ti-OOO lo-O.OO C-357.42 V-O
(DD+)
360.00
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32500
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Figure 5.20 indicates that the RSI is breaking out from its potential descending channel.
Ifthis is correlated with the latest (DD+) signal, at PointsA' and B', the RSI appears to
be slipping into the next RSI segment within its ascending channel. This also means
that the violation ofthe ascending channel at Point B' should have no adverse effects.
Normally, such violations would indicate that the RSI is leaving its ascending channel
and continuing downward along Line A'-B' . With values above 70, the RSI advance
into Point Z' points to a more bullish perspective ofthe market, but the RSI sub-channel
X'-Y' is too steep for comfort. We need to be aware that the RSI will drop below this
sub-channel at some point. The hourly RSI provides us with an early warning.
234

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50.00
45.00
1 �
L-
-
-
-
�
�
�=
-
-
-
-
-
-
-
-
��
t3.
?-:
�
�
...-...=
:;;:..::::
:..-
--
-
-
-r40.00
� 35.00
30.00
Again, the sub-channel X'-Y' is too steep for comfort. What does this mean? This
channel is temporary and the RSI will likelyreturnto a more acceptable channel slope.
What is "acceptable"? Look back at the previous phase in the uptrend. From Point A',
the RSI starts in a steep sub-channel along the line connecting Point A' and Point 1 .
This path is too ambitious; the RSI breaks below this line and drops to Point 2, defining
a less steep channel along Line A'-2. This line is violated and another channel bottom is
defined along LineA'-3.
IfPoints 1 , 2 and 3 are connected, you get a (DD+) signal within an ascending channel.
Line A'-3 proves to be the lower boundary ofa significant ascending channel, as itwas
broken prior to Point X', thus signaling the start of a sizeable correction downward.
Line A'-3 can be labeled "acceptable." If a parallel (dashed) line is plotted through
Point B', we get an impression ofwhat could be an acceptable lower boundary for this
channel.
Now, let's simulate an RSI drop to this line from Point Z' into the rectangle at Point D'.
This is still above 40, so we may expect the formation ofa (DD+) signal when the RSI
reverses up at Point D'. A logical origin for this imaginary (DD+) signal would be the
crossing ofthe moving averages at Point C'. In our scenario, this means that price can
be expected not to drop below 345, (the price level corresponding to Point C' in the
RSI). This imaginary scenario provides an idea of what to expect when things tum
sour. If the RSI should drop below the Line B'-D', all bets are off.
235

Walter 1. Baeyens
348.00
344.00
3'2.00
340.00
338.00
336.00
SO.OO
v-�==-:"'""""'::::::"-'-_140.00
30.00
r------�-------L��------------��::====�----__
__
__
__
__
__l�·oo
10.00
7r27 8m 8M 8/17 812' 9()1 9111 9118 9125 1003 10na 10117 1012S 11m 1 1 ()B 11ns 11 124 12m 1M1 12n8 12126 11 35 1 n 2 1122 1/29 17:30
The RSI continues up from the area at Point Z', while price advances further, after its
bounce off the (DD-) Lighthouse level. I have adjusted the upper boundary of the
ascending RSI channel, connecting Points X and W more accurately. The adjusted
parallel lower boundary is now closer to Point Z', so the recent (DD+) signal can be
considered complete, having formed near the channel bottom. The rally is safe as long
as the RSI stays within its ascending channel.
236

J( • Doily AloE)( L-J60.25 .0.00 .0._ B-J6OD7 A-J60.'O 0-0.00 _00 Lo-ODO c-360.25 v-o
;A��J 34500
�I�I �i �
�
--
--
--
--
--
--
--
--
--
-1
�
�
�
--
--
--
--
--
--
�
�
�
�
--
--
--
--
--
--
--
-f�oo
B
100+)
Figure 5_23 Daily DRG (January 25, 2007)
335.00
33).00
325.00
100.00
9ODO
20.00
10.00
The RSI bounces offofthe 9-day simple moving average again, as shown by the arrow.
This reversal up causes a FAST (DD+) signal at the 65-level, coinciding with the (DD+)
signal at 40 in the hourly chart. We continue to maintain the long position initiated at
356.
237

Walter 1. Baeyens
7121 7m S'()3 8f11 8118 6125 9.()5 9112 9119 9126 10.04 10111 10118 10126 11lJ2 11.()9 11116 11(27 12Al4 1 2112 12119 12127 1.(18 M6 1(23 11X1
f Iiill
D.lIIed WIth T,odeSt"""
The RSI drops back to Point Z'. This is not a problem; the ascending channel remains
intact. Price drops back to test support once again and can be expected to reverse
upward. However, we should prepare to exit our long position when the RSI drops out
ofits channel, which could possibly occur in the next session.
238

.x . Deily AhEX l-35630 +0,00 +O.OO'l. 8-355.55 ,6,-355.82 0-0.00 Hj.O.OOlo-Oro C",356.30 V..O
360.00
35000
34500
t--------.:-----------t---J'IOI-------1l'!�=------------f340.00
335.00
(000) 33000
325.00
00.00
8500
80.00
75.00
70.00
E'
- - 5000
---
0' 45.00
.00
35.00
3000
A
frlll
Cre¥ed Mh TredeSteOOn
We now see disappointing price action, The gains from the previous day were lost and
we can see that yesterday's price drop resulted in a Bearish Engulfing Candlestick and
Tweezers patterns, which usually points to continued market weakness, The RSI drops
below its 9-day moving average and we need to monitor whether it will rebound from its
sub-channel Line B'-E' or from its "acceptable" channel boundary B'-D', It looks
likely that a further price decline is in the cards to the 350-345 area when yesterday's
price low is broken, We intend to stick to our trade plan to exit our long DRG position
when the hourly RSI breaks the boundary ofthe ascending channel.
239

Walter 1. Baeyens
7121 7127 8Al3 8111 8118 8125 9.05 9112 9119 9126 1004 10111 10118 10126 11.(12 1UJ9 11116 11127 1204 12112 12119 12117 1.00 1116 1123 100
( IiIl1
ueated win TradeStatDl
Figure 5.26 Intraday Hourly DRG (January 26, 2007)
The DRG opens lower, and, as we have discussed, the long position is exited.
240

RS[: Logic, Signals & Time Frame Correlation
362.00
36000
348.00
346.00
344m
342.00
340.00
336.00
r----------1-;:l-------=--I.L=�:::===�=_=�==��:�_
_l20·oo
(DO.)
10.00
9113 9J2O 9127 1o.cs 10112 10119 10127 11m 11110 11117 11128 1205 12/13 12120 12/28 1.()9 1117 1124 1131 17:3(l
�
Cleated wIh TredeSlation
At the close ofthe session, the RSI rebounds offthe next lower (DD+) reference line
at Point A', which is near an RSI value of25. The dashed line through Point A' is the
potential lower boundary of a new ascending channel. A reversal down ofthe RSI at
this level will result in lower prices. The formation ofa W-pattem in the RSI at PointA'
could cause price to drop to 348.
241

Walter 1. Baeyens
360.00
350.00
3<5.00
f---------;:---------+---"'IIII---------I!b,.L:.----------f3<O.oo
(DD+)
335.00
330.00
325.00
!Il.oo
85 00
aeoo
�_
_
_
_
_
----:----------:::::-:::;:""�c::::..::::.;_--�
rr-----;:
i:;::7".:.----�75.oo
u 70.00
E'
045.00
�_��====;��===[.O.OO
35.00
30.00
A A
lim
Cre�ed WIth TladeSt�1On
The RSI drops below its 45-day moving averages. Weneed to wait for the formation of
a (DD+) signal somewhere on the Line C'-D'. This means slightly lower prices.
242

7f24 7128 8Al4 6114 8!21 8128 9,0; 9113 9f2O 9127 1 0AJ5 10112 1 0119 1 0127 11Al3 11�0 1 1 n 7 1 1 128 12J1lS 12n3 12J20 1 2128 1J1l9 1M 1124 1!l1
� �
Cleated wih TrodeStal""
Figure 5.29 Hourly DRG (January 27, 2007 - revised)
This is the revised logic for the RSI picture studied earlier (in Figure 5.27). Here is the
reasoning for the change: At Point W, the RSI breaks from its descending channel.
This is an indication that a new ascending channel could be building. The channel we
have been concentrating on so far is the ascending channel, or sub-channel, defined by
Lines X-W and U-Z'.
Now, the RSI drops below this channel to Point A', where a new (DD+) signal forms.
Whatdoes this mean? Ifthewidth ofthe descending channel is measured and compared
to the width ofthe ascending channel X-W-U-Z', we notice that this recent channel is
not sized for an equivalent ascending channel.
So, it mustbe a sub-channel; but a sub-channel within what? It is not within the existing
descending channel because it broke out at Point W. It must be within a new ascending
channel, which becomes clear as the RSI drops to Point A'.
243

Walter J. Baeyens
CHANNEL WIDTH
9113 9f2O 9127 1(),(15 1M2 10119 10m lUll 11110 11117 11f2S 120S 121'13 12120 12ne HJ9 1117 1124 lJ31 2.()8 19:30
Figure 5.30 Hourly DRG (January 27, 2007, revised)
36200
360.00
348.00
346.00
34'.00
342.00
340.00
338.00
10.00
Channel V-W-U-A' has a width equal to the width ofthe descending channel it replaces.
In this instance, we have a (DD+) signal in an ascending channel, which is bullish. The
only bearish element is that the hourly (DD+) signal forms in bearish territory around
25. In the daily chart, the RSI is still above 50. The main reference line is the channel
boundary U-A'.
Ifthe RSI builds a W-pattem on this line, we should see slightly lower prices. Logically,
the RSI should rise (approximately) to the 75-level, meaning a higherprice high is in the
making. Why the 75-level? Ifa line is plotted through Point W, parallel to the (DD+)
reference line ending at PointA', we have defined the upperboundary at around the 75-
level ofa descending sub-channel within the ascending channel.
244

(DO.) Lighthouse
CHANNEL WIDTH
36200
360.00
34600
344.00
342.00
340.00
33800
1000
8/14 8J21 8128 9.00 9113 9J2O 9121 10m 10112 10119 1 0127 11.(13 1 1 f1 0 11117 11126 12Al5 1 2t13 12120 1 2128 U)9 1117 1124 1131 2Al8 2I1S
lim
ae�edwCh TradeStaiion
Figure 5.31 Hourly DRG (January 3 1 , 2006)
The RSI moveshigher from PointA', but since this is still bearish territory, price merely
moves sideways. In fact, the market indecision causes the formation ofa small triangle
in price, visible in the I 5-minute chart (not shown). In the daily chart, the inside day
candlestick within the range of the previous day's candle reflects this activity. The
Doji-like candle features upper and lower shadows (or wicks), indicating that price has
been fluctuating without exceedingtheprevious day's high or low, resulting in the triangle
(in the smaller time frame).
245

Walter J. Baeyens
)(. Daily AMEX La352.63 +0.00 +0.00% Bc3S2.59 A..352.83 QaO,(() H=O.OO LOt=O.OO C..352.63 v..o
(00+)
E'
360.00
355.00
345.00
340.00
335.00
330.00
325.00
�.OO
85.00
00.00
75.00
70.00
65.00
45.00
40.00
L
_
�
_�
-
----::-::::-
�
�
-
-f
35
.
00
- -
�
A
Iilil
Cleated wah T,edeS'oIion
Figure 5.32 Daily DRG (January 3 1 , 2007)
The RSI holds above 50, but has yet to reach the Line B'-E', which would be a solid
reference for a (DD+) signal andthe subsequent rebound. Yesterday's intraday triangle
should be expected to break to the downside because triangles are considered
"continuation" patterns. This meansthatthe hourly RSI will likely dropback to Line U
A', pushing prices to a new low. In the daily RSI, this means the RSI hits Line B'-E',
which would be a logical scenario.
246

(DO.) Lighthouse
36200
352.00
350.00
348.00
346.00
344.00
342.00
340.00
336.00
1-----:---r-_+-__--:.._
-
-
-
�
�
�
�
.......
1F:::::===F�;:!=r90·oo
40.00
��=====��-�30.oo
I 20.00
10.00
8124 Wi 9111 MB 9125 10m 10110 10/17 10125 1UH 1H18 11115 11124 1 2.()1 12111 1 2f1B 12126 1.os 1112 1122 1129 2.0) 2113 2120
I.illJ
Created "'h T,adeSlaiJon
Figure 5.33 Hourly DRG (February 2, 2007)
Price initially breaks to the downside from the small triangle in price, but a Fed
announcement "lifts all boats" anda rally follows. Price bounces offthe (DD+) support
line around 352. The rally propels price up to the (DD-) Lighthouse reference level. In
the RSI, this causes a potential (DD-) signal at Points Q'-R', but the (DD-) signal
seems to be incomplete, as it is not building in the area around Point S'. This means that
the RSI may have another down/up sequence before it reaches Point S'.
Notice that Point S' is at 75 (in bullish territory). Given this fact, I doubt that price will
be lower than 360. This is the price level corresponding to Point Q' in the RSI when the
RSI finally hits Points S'. As a result, there may not be a (DD-) signal at Points S'.
In this perspective, a reversal ofthe RSI down from Point R' should result in a price
drop to the support line (in the 353 area) before we get anotherrebound. Again, a first
sign oftrouble will be an RSI drop below Line U-A'.
247

Walter J. Baeyens
360.00
350.00
345.00
1-
---------t----lIl'Tdl----------fII!--=---""'----t---------f340.oo
B 347.60
335.00
m.oo
325.00
L__
��----��--------r�.oo
- -
�
AUO Oct Apr
1il 0
Crellted with TfadeStatic:n
Figure 5.34 Daily DRG (February 2, 2007)
The RSI continues up after its reversal at Point F'. This means that we have a (DD+)
signal at Point F', on Line F' -G', originating at the RSI extremity near Point C'. This
corresponds to a price level of347.60; pricewill not drop below this level as long as the
(DD+) remains valid.
Reference line C' -D' is a tentative reference line where we could expect the formation
ofa (DD+) signal. I plot this line from Point C', as this is where the moving averages
cross up. Now, it appears that the expected (DD+) signal is building on Line F'-G'. A
continuation ofthe rally is certainly a possibility, but this signal looks to be incomplete.
Additionally, both moving averages are negative and are about to cross near Point H'.
Given the potential ofa (DD-) signal in the hourly chart, we remain cautious in our
approach.
248

OX · 60 min "hEX L-356.18 +0.00 +0,00% �355.97 A-356.47 0-0.00 1-1-0.00 lo-O.OO C-356.18 V-O
(DO·) Lighthouse
362 00
360.00
35200
35000
34800
34800
344.00
3<2.00
3<000
90.00
�r=======�==::�======��;;��=---��::��::�t:��ba'oo
F L......;.
-
-l,o.oo
60.00
<000
r"��======��:=::::;::::::::===�3000
� 2000
10.00
1Ul8 11110 11115 11117 11J22 11128 1W1 12.0S 12Al8 1 2113 1 2118 1 2120 12126 12129 1.os U19 1112 1118 1122 1125 1.00 2m 2.()6 2.09 1 1 30
[i] III
Ct...
ed will 1,adeSt"'"
The RSI reverses downward from Point R', producing a (DD-) signal. In the price
chart, the conflicting (DD+) and (DD-) reference lines define a triangle. The indecisive
bull-bear fight causes the RSI to yo-yo around the RSI 50-level.
249

Walter 1. Baeyens
(DO.) Lighthouse
362.00
360.00
350.00
m.oo
34Il.OO
344.00
342.00
340.00
I ' =
�
��
===�
�
�
====-_�30.00
� 2000
10.00
11121 11128 Dec 1215 12fl 12113 12119 12126 '07 115 119 1111 1116 1118 1122 1124 1126 1130 Feb 215 2R 219 2113 2115 2119 2 2123
I.aI ill
Cleoled wjh T,odeS!otion
Note that price is still moving within the triangle. We still have a valid (DD+) signal at
Point A' and a valid (DD-) signal at Points Q'-R'.
250

.x - Daiy AhEX l-3S4.71-1 .85 -0.52%e-354.45A-354.90 0·356.56Ii-3SS.S6Lo"'3S3.70C..354.71V-o 36500
345.00
1------+-..!.l1fIiIl-----------ff1!-..."".....-.:::'----+---------f340.oo
341.60
335.00
330.00
Aver_ () 53.00 5<.40 5521
90 00
c.eated wlh TI�St�ion
The RSI reverses downward from Point H', (where the moving averages cross). A
further decline to Point J' seems likely. Given the (DD-) signal in the hourly time frame:
will the RSI reverse upward from Line B'-J'? Or will it continue downward to Line B'
G'? Let's wait and see which way the triangle breaks. Note that the origin of the
potential (DD+) signal on Line F' -J' is different than those we have seen in the hourly
time frame.
251

Walter 1. Baeyens
.x · 60 min AM')( l_.71 0.00 0.00'<> 13:354.45 A.354.9J 0-000 ft.().OO looO.OO C.354.71 V.o
Q
:J62.00
lighthouo.
350.00
348.00
346.00
344.00
w
S'
S'
I _
_
_
_
_
�
_
_
_
___..:
==
::::::
=
�::::::::
==
=--
-
-
-
-
-
-
-
-
-
-
-
-[30.
00
I- lV.OO
10.00
12128 U7 114 115 1� 113 1�1 M6 1M 1 122 1124 1/26 1130 Feb 212 2!5 2Al 2!1 2-'1 213 �3 �5 �9 2121 2123 2127 Mar 312
1il 0
Cleated win T,adeStaliln
Figure 5.38 Hourly DRG (February 8, 2007 - revised)
In the hourly chart, ifthe potential (DD+) reference line (detected in the daily chart) is
plotted, we end up with above picture. Line C'-A' is the new (DD+) reference line.
Line C'-A' is steep, which indicates that it is probably a sub-channel, as an RSI down
leg within the ascending channel.
In the price chart, the corresponding support line nearly coincides with the existing one.
(Parallel) Line W-R' is the validity line for the (DD-) signal at Points Q' and R'. Line
A'-B', which is parallel to Q'-R', is the validity reference line for the (DD+) at Points
C'-A'.
In short, a triangle is building at the RSI value of 50. If Line W-R'-B' is broken, the
(DD-) signal at Points Q-R' will be invalidated, but another one may form at Point S'.
IfLineA'-B' is broken, the (DD+) signal will be invalidated and the (DD-) signal could
take effect. In this worst-case scenario, the price target for the (DD-) target at Points
Q'-R' is:
35 1 .70 - (360 - 357.60) = 349.30
252

362.00
360.00
(00-) lighthouse ,...00
356.00
354.00
35200
350.00
348.00
346.00
344.00
342.00
S·
Figure 5.39 Hourly DRG (February 1 0, 2007)
At the close ofthe session, the RSI breaks through Line A'-B'. Ifthe descending sub
channel, W' -R'-C'-A', is in force, the RSI should drop below its ascending channel,
entering bearish territory. Given the existence of the (DD-) signal, with its target at
349.30, but with-the potential of a new (DD+) signal (as long as price does not drop
below 347.60), a realistic price target could be at 350.
253

Walter 1. Baeyens
.x. DeIy .A.MEX l-3S3.12 ·122 ·0.34% B-353D4 A-35352 0-354.44 ....355.44 lo-353.09 C-353.12 V-O
365.00
360.00
350m
345m
f------If------"''trlI-----------It't--=---''''''----t----------f340.00
B
A�s 0 4S.oo 54.25 54.EIl
347.60
336.00
330m
00.00
z·
c· -
-
-
G- -
- .500
-
-
- - - - - �
- -
L�_
_
_
_
_
_
_
_
_
_
__
:::::-:=-_Jt,�=-=:::.-=------------(35.oo
- -
-
Sop Cd Nov Feb
Deale<! w<h ,,odeSlotion
Figure 5.40 Daily DRG (February 1 0, 2007)
The RSI reaches Point J' on the potential (DD+) reference line F'-J'. A reversal ofthe
RSI to the upside would produce a (DD+) signal here, but the hourly RSI points to a
further decline. If the RSI continues down, we will have to wait for a (DD+) to form
somewhere on Line B'-D'-G', possibly in reference to Point C'.
2S4

OX - 60 m AAEX l03S4.15 0.00 0.00% a-354.04 A-354.'9 0-0.00 H-O.OO lo-O.oo C.354.15 v.o
(00-) lighthollse
S'
11129 Dec 1215 12fl 12N3 12N9 12126 '07 1/5 1/9 lNI lN6 INS 1122 112. 1126 1130 Feb 215 2fl 2/9 2N3 2N5 2N9 2J21 2f.!3 2f.!7 "'"
36200
350.00
3<8.00
3<8.00
34'.00
342.00
g).00
00.00
70.00
fil GEl
C,ealed will T,odeSt"""
We see the RSI reverse up, within its descending channel. It is clear that a (DD-)
signal may form in this channel, ifthe RSI reverses down atPointT' andprice does not
exceed 356.
255

Walter J. Baeyens
Doiy AMEX l-354.15 0.00 0.00% 8-354.04 A·354.4S ().().oo ti-O.oo LO-O.OO C-35415 V�
Sep
IaIl W
D...ed will T,ede$lation
The reversal up produces a (DD+) signal in the daily chart in Figure 5.42 on Line F'-J'
G'. However, we have noticed the potential for a (DD-) signal in the hourly chart. If
we are looking for an opportunity togo long, the (DD-) signal in the hourly time frame
must be invalidated first. Price needs to rally above the potential (DD-) Lighthouse
level at 356 first.
The RSI moving averages are slightly negative and may cause resistance. An RSI
reversal down from the moving averages in this time frame could coincide with the
formation ofa (DD-) signal in the hourly time frame. Before a long position is taken in
DRG, we need to see price rally above 356 and the daily RSI must break the moving
average resistance. The hourly RSI must break out of its descending channel, thus
avoiding or overcoming the potential (DD-) signal.
256

(OD-) Lighthouse
S'
Dec 1215 1217 12ltJ 12119 12126 W 213 2113 2J15 2119
Figure 5.43 Hourly DRG (February 1 5, 2007)
362.00
360 00
"'.00
"'.00
352.00
350 00
348.00
34600
3« 00
34200
2n7 .....
iii m
Cleated wtil TladeSlabon
A Fed announcement about weakening inflation propels the markets higher. The RSI
breaks Line W-R'-B', causing the formation of a timid (DD-) signal at Point T' and a
timid (DD+) signal at Point E', resulting in a positive wedge in price. A price advance
from herejustifies a long position in DRG, with a stop-lossjust below the wedge line.
257

Walter J. Baeyens
Daiy AIIIEX L-3S6.56 -0.02 -O.o1'l. 6-356 34 A,..3S6.62 0-0.00 ti-O.OO lo-O.OO C-356.58 V-O
Figure 5.44 Daily DRG (February 1 5, 2007)
Following the formation of a (DD+) signal at Points F'-J', the RSI breaks above the
moving averages. Price hits the previous (DD-) Lighthouse resistance line. The rally
is safe as long as the RSI remains above Line B'-J'-E'. However, if the RSI breaks
below this line, we can expect the indicator to drop to Line B'-D'-G', where it should
form another, more modest (DD+) signal.
258

362.00
$ORG X · 60milAMEX L-350.75 0.00 0,00% &0350.49A..350.810.0.00HiaO.OOlo-O.OOC-3SO.75v·a
Q
360.00
(DO.) lighthouse
308..00
308.00
354.00
352.00
348.00
346.00
344.00
$IAverages () 26.31 S'
10.00
12122 12m '07 H4 115118113 1111 1116 1118 1/22 1124 1126 1130 Feb 2(22.152.452n218213 2113 2115 2121 2m 2/27
1iI 0
Created ¥Mh Tf<'JdeSt�ion
A few days have passed; a downward reversal of the RSI at Point T' gives us reason
to amend the analysis ofthe RSI picture. In the previous hourly chart, a triangle was
defined in the RSI, but with no follow through. Now, Line W-T' defines a plausible
descending channel with a (DD-) signal at Point T'.
At Point D', the RSI violates boundary Line A'-E' ofthe ascending channel. This drop
effectively invalidates the (DD+) signal at Points F'-E' because price drops below the
Lighthouse level of this signal. In short, a potential descending channel exists with a
valid (DD-) and an invalid (DD+) signal. This picture is bearish until the RSI manages
to break out to the upside from its Channel W'-T' .
259

Walter J. Baeyens
- [)ely ME)( l-3S0J5 000 o.� 8-350.49 "-350.81 0-0.00 Ii-D.OO lo-O.OO C-350.75 V.,JJ
iii ill
Cleated wlhTr&deStation
The RSI reverses downward from 60 again, as price is unable to break the resistance
level corresponding to the 357 Lighthouse level ofthe (DD-) signal (originating in Point
X'). The RSI drops below Line B'-J'-E', invalidating the (DD+) signal at Points F'-J'.
It is expected that the RSI will drop to Line B'-D'-G', where a new, less ambitious
(DD+) could form.
This brings us to the earlier hypothetical scenario where we anticipated a (DD+) signal
to form in reference to Point C', at the crossingpoint ofthe moving averages. Remember,
Line B'-D'-G' is plotted as a tentative reference line, parallel to Line 3, because Line
B'-D'-E' is too steep for comfort.
It should not be assumed that the RSI breaks Line B'-D'-E'. Rather, a reversal up of
the RSI at this point creates a (DD+) signal in reference to Point C'. Given the fact
that price reaches a major (DD+) support line, a rebound is likely. If the reversal up
materializes, we will be able to adjust and anchor the channel and (DD+) reference
lines.
Even if this bullish scenario unfolds, we know that the hourly chart is bearish and the
potential hourly (DD-) signal must be invalidated first. In the daily chart, the RSI
moving averages cross downward and the RSI sits on the edge of bearish territory.
Consequently, we should delay entering a long DRG position until the expected (DD+)
signal in the daily chart invalidates the (DD-) signal in the hourly chart.
260

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Figure 5.47 Weekly DRG (February 23, 2007)
The RSI progresses within ascending Channel C' -E'-F', but fails to rise into the next
RSI segment at the arrow symbol and the negative divergence becomes more clear.
The recent RSI top reaches a value of70, which is respectable, but not really convincing
in a bullish scenario. Logically, we should see the RSI reverse upward from Point F'
where another (DD+) signal should form.
However, if the RSI drops below Line C-E'-F', we could expect it to drop to the
extension ofthe nearest (DD+) reference at Line D'-E'. This means that price could
drop to the area around 330 or 325. The daily and hourly RSI will provide an early
indication ofwhere things are headed when Point F' is reached in the weekly chart.
261

Walter 1. Baeyens
j( · 60 nw'I AMEX l-3S0.12 ..0.63 -0.18% 9-349.88 A-3S0.29 0a350.75 tf-350.7S l0-348.9B C-3S0.12 V-o
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The RSI continues downward at Point D' before reversing up from the 20-level. Price
violates the (DD+) support line at the important support level at 350. The picture is
turning bearish. We have to anticipate the formation ofanother (DD-) signal within the
Descending Channel W-R-T'. This points to a lower high in price, unless the RSI breaks
out from its descending channel.
262

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I have adjusted the reference lines C'-D' and B'-D' in the daily chart, as the RSI
reverses up. Remember that Line B'-D' is an acceptable lower boundary for a potential
ascending channel. It is also the validity limit line ofthe (DD+) signal at Points C'-D' .
Price bounces off the main (DD+) support line. These elements are all bullish, but
there is a valid (DD-) signal that will need to be invalidated and another (DD-) in the
making in the hourly chart.
The moving averages cross downward, which could prove to be an additional obstacle.
In fact, this RSI configuration is not unlike the one witnessed at Point X' in early November
2006. For this reason, I have labeled this area ofthe chart "X2?"
263

Walter 1. Baeyens
.x- 50 "*' AtE)( L-34327 .0.02 .0.01% 6-343.05 ....343.40 0-0.00 H-O.OO Lo-O.OO c-J43.29 V-O
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When the RSI reverses down at Point U' in the hourly chart, the third (DD-) signal that
was expected does in fact materialize and the subsequent sell-off takes price down
over 2.5%. The RSI value is compressed at the 1 7-level, near the bottom ofdescending
Channel F' -E'-D'. Within this channel, we witness the formation ofthree (DD-) signals
without a valid (DD+) signal. As soon as the selling pressure relaxes, the compressed
RSI is going to spring up to the rectangular area, where another (DD-) signal is due to
form. Price breaks the triangle to the downside. Let's check the daily chart to see the
Lighthouse level for the main (DD+) signal.
264

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The hourly (DD-) signal takes the upperhand and causes the invalidation ofthe daily
(DD+) signal as the RSI drops below Line B'-D' -G', The descending Channel A'-B'
E' is in force, as the RSI also violates its ascending channel boundary, invalidating the
(DD+) signal at Points A'-B'. There is a potential (DD+) signal in the making at Point
E' in relation to Point B' . If this fails, the drop in price could extend to the (DD+)
Lighthouse level at PointA (320!).
265

Walter 1. Baeyens
Figure 5.52 Weekly DRG (February 28, 2007)
Caution: thisweek is not over, so we shouldnotjump to conclusions until afterthe close
ofthe week. Still, this chart illustrates the use ofmy Time Frame Correlation method.
The RSI has reached Point F'. A reversal up from Point F' will produce a (DD+) signal
within the ascending ChanneF, well above the 40-level. This is all bullish.
We have reason to be cautious - inside the ascending ChanneF C'-E', the RSI fails to
break out (shown by the arrow) and the most recent RSI top is situated at 62. In other
words, we may see the RSI continue down at Point F' into the rectangle area, where a
(DD+) signal could be formed in relation to Point E'. A more likely scenario would be
if the RSI were to reverse up from Point F', but this will lead to the formation of a
(DD-) signal in the daily time frame.
This daily (DD-) signal could prevent the weekly RSI from breaking outnear 60. The
subsequent RSI drop will likely be violentandcould take the RSI down tothe extended
Line D'-E', (which could see price at �20). In the daily time frame, we need to monitor
the formation of a (DD-) signal and its effects, which will first become visible in the
hourly chart.

RSI: Logic. Signals & Time Frame Correlation
PART II
CRUDE OIL FUTURES (CL)
These days, the general public all over the world watches crude oil prices. Following
the Iraq war and the "peak oil" issue, oil prices have exploded upward in the last few
years. As we have witnessed a price drop from $75 to $50 in the second halfof2006,
the question on everybody's mind is: Will oil prices continue down or resume their
uptrend? Let's start our analysis with the longer-term weekly crude futures chart.
L-55,09 '().28 -0.5'" 9-55.11 ....55.13 00055.39 tt-55.39 L0-54.95 C-55.09 Y-3316
Figure 5.53 Weekly Crude Oil (January 25, 2007)
PastPoint X, the RSI takes a tumble intobearish territory. Point D' is nearthe 30-level.
The descending channel along Line A'-B' -C'-D' could be the RSI transition from its
earlier ascending channel (dashed lines labeled I ) to a new ascending channel (labeled
2) starting at Point D'. In this scenario, the price rally should resume soon and the RSI
could be on its way to the 75-level once again, taking prices to new highs.
Ifthe RSI fails to escape from its descending channel, a Head & Shoulders formation
is in the making. Note that the most recent price decline to Point D does not result in a
(DD+) signal in reference to Point C, but only in reference to Point B and Point A.
The RSI is in bearish territory, which means that a small bounce in price will send the
RSI higher. In this scenario, the RSI would rise to the area around Point Y, where a
(DD-) signal will form unless price is above $74 at that point, which is unlikely. This
duality is expressed in the RSI by the building triangle centered on the 50-level. So,
while the longer-term price trend is still up, the resumption ofthe rally isnot guaranteed,
as a (DD-) signal in the weekly time frame may be overcome in the near future. What
is the situation in the daily time frame?

Walter 1. Baeyens
) - Daily NYhEX L-SS.17 -020 -0.36% e-sS 17 A-SS.19 0=-55.39 Hr-SS.39 lo-S-4.95 C-SS.17 V·3231
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Figure 5.54 Daily Crude Oil (January 25, 2007)
Like the weekly RSI, the daily RSI moves within a descending channel. Up until
September 2006, it is the channel bottom that def
mes a (DD+). The last (DD+) signal
is formed in bearish territory around 30. After the steep price drop to $57, a mere price
consolidation is enough to push the RSI up to 65 in December 2006. Of course, this
leads to the formation ofa (DD-) signal.
At Point X, the RSI drops below its potential ascending channel and the (DD-) signal
takes effect, invalidating the (DD+). In short, the RSI fails at its first attempt to catch
an ascending channel, which could have enabled itto escape from its descending channel.
The recent price rebound causes the RSI value tojump 30 points higher. It is clear that
another (DD-) signal must be in the making.
Let's not forget that a downward reversal of the RSI will immediately send prices
lower, (with a vengeance!). With an RSI dropto the 20-level, we will see price reaching
new lows, probably around $46. The price rebound cannot be taken seriously until the
RSI takes hold above (at least) the 40-level.
268

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Cleatedwen TradeStation
Figure 5.55 Hourly Crude Oil Futures (January 25, 2007)
Here, we should get an early bear warning. With both the daily and weekly charts in
bearish territory, the recent rally looks very fragile. In fact, we have to assume that the
price advance is just an upward correction in a bear market. The hourly chart shows
the RSI traveling in ascending Channel X-Y-Z-A-B for quite some time.
At its start, Points X and Y define a (DD-) signal within a descending channel, but at
Point Z, the RSI breaks out and rises to 80. The Line X-Y-Z still defines a (DD-), but
the RSI is in bullish territory, failing to break below its ascending channel. Meanwhile a
(DD+) signal appears to be forming while price is breaking the (DD-) resistance line.
Note that there is a positive divergence in the chart.
In the price chart, the (DD+) and (DD-) reference lines define a triangle. The price
rebound will continue as long as the RSI stays above LineA-B, but we should not forget
that this price advance should be considered a retracement up in a bear market, as it
will cause the formation ofa (DD-) in the daily time frame.
Let's assume that we are looking for an opportunity to short the crude oil market. We
should delay our entry until the (DD+) in the hourly chart is invalidated and the RSI
drops below Line A-B, possibly after the price retracement up causes the formation of
a (DD-) in the daily chart.
269

Walter J. Baeyens
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Figure 5.56 Hourly Crude Futures (January 30, 2007)
After a briefprice surge to $56, the moderate price decline causes a deep drop in the
RSI. The RSI reversal at Point B means a (DD+) signal at Points C-B within an
ascending channel: this is bullish. The corresponding price support line is less steep
than the previous one. The only drawback in this scenario is the negative divergence
building. We will need to monitor the RSI, to see if itjumps into the next higher RSI
segment. Ifnot, it will reverse down from the 60-level for another test ofthe channel
boundary, LineA-B.
The dotted line through Point Y is the upperboundary ofthe previous descending channel.
Technically speaking, we have a (DD-) signal at Points X-Y-Z, so I have plotted a new
parallel descending line at Point Z. This line is the mirror image of Line A-B, which
promises to become the lowerboundary ofthe new ascending channel. The question is
whetherthe ascending Channel X-Y-Z-A-B is a transition fromone descending channel
into the next (higher) one, followed by a new price decline or whether it will prove to be
the lead-in scenario to the resumption ofthe long-term uptrend. The bearish scenario
means that the RSI will break below Line A-B and will engage in a new descending
channel. Moving the previous boundary the same distance as the top was moved from
Y to Z can be used to plot the lower boundary ofthis potential channel.

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Figure 5.57 Hourly Crude Oil Futures (January 30, 2007 - revised)
This is the revised (tentative) RSI picture, reflecting the potential bearish scenario that
we have discussed with the potential descending channel defined by lines labeled 2.
The arrows indicate the distance the old channel is lifted. Most ofthe lifting is the result
ofthe positive divergence pushing the RSI up, while price keeps falling.
The upper boundary ofthis descending channel runs parallel to the previous channel
prior to Point Y; conversely, the lower boundary only touches one RSI extremity on
January 9. Ifthis picture was valid, we would have a (DD-) signal at Points V-V, within
a descending channel, with a valid (DD+) signal at the same time. Things will become
more clear when the RSI either breaks above Line V-W (indicating a bullish scenario)
or breaks below Line A-B (indicating a bearish scenario).
171

Walter 1. Baeyens
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Figure 5.58 Hourly Crude Oil Futures (January 3 1 , 2007)
Interesting! The RSI continues upward and breaks Line V-W with ease, reversing
down when hitting the upper boundary ofthe ascending channel at 85. This means that
the RSI is making its way into the next RSI segment. The RSI is definitely traveling
within its ascending channel, which makes the "transition channel" scenario less likely.
272

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Figure 5.59 Hourly Crude Oil (January 3 1 , 2007 - revised)
Within the ascending channel, the (DD+) signal takes effect and the RSI breaks the
negative divergence. In this time frame, the market is clearly in a bullish mode. The
potential descending channel (plotted yesterday) does not make much sense. After the
RSI reverses downward from Point Q, a new tentative descending channel can be
plotted.
Line 2 is moved so it can run through Point Q; the lower boundary line is moved up the
same distance. This much better! Line D-B could be considered the lower boundary
ofa future descending channel. Line D-B defines a (DD+) signal, which comes as no
surprise after the RSI reaches 85.
In any case, this small rally will be safe as long as the RSI stays above Line A-B. A
new (DD+) signal will form soon. Ifthe RSI breaks below LineA-B, we will probably
see the formation of a (DD+) signal on Line D-B as well, because the origin of the
(DD+) signal at Points D-B is the recent price low at $50. These elements are all
bullish, but what is their effect in the larger time frame?
273

Walter J. Baeyens
).DeIy NVMEX L-56.75 .0.19 .o.33'Wo 6-58.76 "'-56.78 0-56.90 ti-56.90 L0-56.S1 C-56.75 V-S494
Figure 5.60 Daily Crude Oil (January 3 1 , 2007)
The good news is that the RSI is now well above 40. The bad news is that the recent
price advance is still considered an upward retracement in a bearish market as the RSI
is on its way to produce a new (DD-) signal. I have plotted a tentative (DD-) reference
line just to indicate that the recent RSI rise has been out-of-proportion to the price
advance.
This line originates at an RSI extremity that corresponds to the $6 1 price level. The
RSI now exceeds this reference point while price barely reaches $57. Still, for a
(DD-) signal to form, the RSI needs to reverse down, which may not occur for a while.
The higher the RSI gets before reversing downward, the higher the chances that we
will see the formation of a (DD+) in the daily chart as well. The confluence of the
(DD-) resistance line and the $58 break-down level in the price chart will surely show
some effect soon. A reversal downward from the $58 level will result in a (DD-) signal
in the daily RSL
174

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Figure 5.61 Hourly Crude Oil (February 1 , 2007)
This chart shows how price continues up after the RSI reverses down from its high at
Point Q. We can expect the RSI to drop from Point W to Point R, where a new (DD+)
signal should form. The potential (DD+) reference line at Point R is tentative but
realistic. This line originates at an RSI extremity that corresponds to the $54 price level.
Price reaches the resistance line at $58. In the daily RSI chart (not shown), the moving
averages cross upward, which adds another bullish element to the picture.

Walter J. Baeyens
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Figure 5.62 Hourly Crude Oil (February 2, 2007)
While price struggles at $58, the RSI drops to the 40-level, where it reverses up, forming
a (DD+) signal. It certainly looks like price will attempt to break $58 soon.
276

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As expected, the RSI forms a (DD+) signal near Point R, above 40. The rally that
follows propels price above the $58 resistance level. Next, we should see the formation
ofanother (DD+) signal on the reference line running through Point R, which is now the
lower boundary ofthis new RSI segment. The ascending channel takes the RSI into
bullish territory. The rally is safe as long as the RSI stays above Line A-B.
277

Walter J. Baeyens
NYMEX la58.63 ..0.55 -0.93% B-S8.63 A-58.54 0.59.25 tt-59.36 looo5e.63 Ca58.63 Y-2824 Mov Avg 1
Figure 5.64 Weekly Crude Oil (February 5, 2007)
At the close ofthe week, the RSI reaches the 45-level and seems to hit resistance at
the 45-week exponential moving average line. The 9-week simple moving average line
is well below the 45-week exponential moving average. Price reverses down at Point
F, after hitting resistance at the 20-period moving average line.
More resistance can be expected as price reaches the 20-week moving average again
at the close of this week. This tells us that a sideways move or moderate decline is in
the cards. The RSI could drop to the 9-week moving average line around the 40-level
before reversing up. Price could rebound from the support line B-D at the $54 level. In
the price chart, Line E-F is the tentative neckline ofa Head & Shoulders pattern, which
could form if the RSI fails to escape from its descending channel. If the downward
reversal materializes in the next few days, there will be a (DD-) signal in the daily time
frame to deal with first.

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There is a (DD+) signal on the reference line at Point R. Price consolidates above $58
and approaches the price resistance line defined around the $60 level in the daily chart.
Let's see ifthe RSI manages to break out and slip into the next chart segment. The RSI
may drop backto form a new (DD+) signal on the reference line near Point S, meaning
that price could drop to $58 before attempting to break the $60 level.

Walter J. Baeyens
(D) - SO m NYMEX L"59.32 0.24 0.41% 8=59.30 A=S9.33 0=59.12 Hi=59.44 Lo=59.09 C.,5932 V:2,9S8
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The RSI reverses downward as expected. Expect a (DD+) signal to form near Point S.
280

RSl: Logic, Signals & TIme Frame Correlation
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The hourly RSI chart shows that the potential (DD+) Line R-S is negated. The RSI
drops to the lower edge ofits ascending channel. We will need to monitor the RSI, to
see ifit stays within its ascending channel or if it starts to decline inside the descending
channel (defined at its lower boundary by Line D-B). The RSI has not reversed up;
when it does, another (DD+) signal will form. Price drops to the $58 level as expected.
281

Walter 1. Baeyens
) · 60 "*, NYlIEX L059.8S 0.05 0.08% Bo59.116 A059.69 OOSS.76 H·6(W L..SS.76 C059.8S V-Ei,295
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The RSI continues down and reverses up offthe descending channel boundary Line D
B-E. Itmust be assumed that this channel is in force. There is a (DD+) signal at Points
B-E and price bounces nicely off of the signal support line. The RSI should reverse
down from the area near Point T, (the upper boundary of its descending channel near
the RSI 80). Near term, higher prices are still likely, but as the RSI continues down in
this channel, the formation ofa (DD-) signal is drawing closer. Prices are testing $60
agam.

Cleated wih TradeSt.tion
Figure 5.69 Daily Crude Oil (February 9, 2007)
The potential for a (DD-) signal is still here. However, the RSI is high enough to
possibly form a (DD+) signal within its ascending sub-channel in the area near Point B',
which is above 40. The hypothetical (DD+) reference Point A' is the crossing point of
the moving averages. In this scenario, price should not drop lower than the price level
at PointA, $54.

Walter 1. Baeyens
(0). 60 mi> NVo.EX l·59.75 .0.09 .0.15% ,,"59.72 A-59.1iO 0-59.78 H-SO.76 l0-59.:xJ C-59.75 V·147.722
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Figure 5.70 Hourly Crude Oil (February 1 0, 2007)
The hourly RSI reverses down from PointT, confIrming that the descending channel is
in force. The minor price retracement down from $60 causes the RSI to drop all the
way to the 50-level, a typical bullish (DD) move. With the RSI reversal to the upside,
we should see price reach new highs, but we know that price will hit resistance at $60.
What happened?

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Figure 5.71 Daily Crude Oil (February 1 3, 2007)
Price retreats afterhitting the (DD-) reference line at $60. The RSI reversal downward
confirms the (DD-) signal at Points X and Y. Point Y is situated at the RSI 60-level.
Expect the formation ofa (DD+) signal at Point B' ifprice manages to stay above $54,
the reference price level at Point A.
285

Walter 1. Baeyens
) · 60 m NYhEX l-S7.70 0.02 0.03% a-S7.68 10.-57.71 0-57.61 H-sa.05 Lo-5725 C-57.70 Y-7,'268
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Cre�ed wth TradeStatioo
The hourly RSI reverses up from Point G, forming a (DD+) signal in reference to Point
F. In this example, the reference prices are identical at $57.70; the price support line
for this (DD+) is horizontal. The recent price rally is weakening. From Point G, there
is a positive divergence building, which could be the formation ofthe first (DD-) signal
in this time frame. The circle marks the hypothetical point where a (DD-) signal could
form near the RSI 60-level. Its Lighthouse price level is $59.50.

) · 60 min NVIIEX L-58.93 .0.08 -0.14% 6-58.91 A-58.94 0-59.03 1ioo59." l0-58.B6 C-s8.93 V-1 ,175
Cleated will TradeSlaIion
Note how the RSI pops up as expected, reaching the area at Point V (circled) near the
60-level. A reversal down will cause the formation ofa (DD-) signal at Point V, within
the descending Channel T-V-F-G. Ifthis scenario materializes, conflicting signals will
be present, defining a negative price wedge with its base line at $57.50. This is the
Lighthouse level ofthe (DD+) signal at Points F-G.

Walter 1. Baeyens
(D) - SO m NYhE)( La58.25 021 036% e-se.23 A-SS25 0-58.D1 tia5827 Lo-57.78 C-582S Y-3,029
56.00
55.00
".00
53.00
90.00
.00
7000
,00
30.00
20,00
B G
10.00
1131 Feb 2n 2", 2.6 2fl 2.e 2J9 2112 2/13 2114 2/15 2/16 2119
I.iillJ
Created WIth Tr�SI&lion
The RSI reverses downward from Point V and fails tojump into thenext chart segment.
This forms a timid (DD-) signal at Point V and a timid (DD+) signal at Points F-G. In
price, the result is a wedge with its base at $57.50. The recent price high could be
considered the right shoulder of a Head & Shoulders formation. If the recent (DD-)
signal at Point V takes effect and price drops below $57, it will be an opportunity to
short the crude oil market.
288

- - -
- - -
- -
- -
foIlIW
Created with T,adeStetion
Figure 5.75 Daily Crude Oil (February 1 5, 2007)
The recent (DD-) at Points X-Y is confirmed. This (DD-) signal is inside a larger
(DD-), which is inside a descending channel. There is presently no valid (DD+) signal
in sight. With some imagination, a (DD+) signal could form at Point B', which should
cause price to stay at or above $54. If the RSI continues lower at Point B', a drop to
Point C' is in the cards. When crude oil is shorted below $57, an initial drop to $54 [$5 1
(Point C) later on] can be expected.
289

Walter J. Baeyens
)·60mNYhEX La57.80 -O.17 .Q,29'If. 6-57.78 A-57.61 o-SS.04 1-1-58.12 Lo-S7.75 C-57.8O V-1ps9
1.00 1131 Feb 2fl 2IS 2.E 2f7
2.19 2112 2113 211�
.00
5900
57.00
56.00
55.00
...00
53.00
Ii111
Cleated wIh TladeStation
The RSI progresses in the triangle. Price on the close manages to stay above $57.50.
We stick to our plan to short crude oil on a daily close below $57.

(0) - 60 min NYMEX l..59.27 0.03 O,OS% e.59.26 ...-5928 0-59.24 ...-59.46 Lo-59.12 C-5927 v·, ,349
215 2.E 2fl 2.t1 213 2112 2 :3 2 4 2J15 2116 2119 2 2122
10.00
IiJiJ
Cleated with TredeStaiion
The RSI breaks the triangle to the upside after a briefintraday slip. There is a (DD-)
signal at Points U-V, but the RSI breaks the signal's validity Line T-V. Price breaks the
wedge to the upside and reverses down from the (DD-) Lighthouse level just shy of
$60. At Point W, the RSI appears to have violated its descending channel. Are we
going to witness the formation ofa (DD+) signal in the ascending channel?
191

Walter 1. Baeyens
(00+) C
IlillJ
Crebled with TradeSt-"101'1
Afteran intraday slide, price manages to stay above $57 (as shown by the arrow on the
close). The (DD-) price resistance line is tested again. There is still a valid (DD-)
signal at Points X-Y; the Lighthouse level for this signal is near $61 .
292

I
(0) . 60 rOO NYhE)( L-sa,40 .o.SO .0.85% B-SS.40 AaSa.41 0-58.89 ....58.95 Lo-58.32 C-SS.40 V-3,m
(DO·)
26 2J9 '"' '", '"' '"5
Figure 5.79 Hourly Crude Oil (February 2 1 , 2007)
'"6 2120 2J21 2m
60.50
58.00
5750
57.00
90.00
ueated with TI�tabon
There is a (DD+) signal at Points J-K, and the (DD-) signal at Points U-W is also valid.
Price reverses down from the (DD-) Lighthouse level and it looks like the conflicting
signals define a positive wedge in the price chart. Point K is in bearish territory, so a
downward reversal of the RSI will send prices lower. Contrary to what the channel
violation at Point W tells us, the RSI at Point K breaks below its ascending channel. To
stay on the safe side, let's say that price is moving in the range from $57 to $60 - the
Lighthouse levels ofthe (DD+) signal and (DD-) signal respectively.
293

Walter J. Baeyens
(0) - 60 nWI NYMEX t-61.30 0.58 0.92% e-61 .29 "-61 .3(1 0-60.12 1-1-61.31 Lo-6O.64 C-81.30 V-4,805
Feb 2J2 � 2A3 � :U3 2112 2113
90.00
8OJ))
The (DD+) signal at Points J-K propels the RSI to the top of its channel. The price
wedge breaks to the upside in a textbook mannet. At Point X, it is not clearwhetherthe
RSI breaks its descending channel. The RSI action past Point X seems to indicate that
this descending channel is still in force. As the RSI is well within bullish territory, each
time the RSI reverses upward price reaches new highs. $60 is a solid support level.

1i1 0
Dooled wih " odeS""""
ThedailyRSI manages to rise above both moving average lines and appears to be on its
way to Point Z. Given the remaining distance to that point, it looks like there will not be
a (DD-) signal at Point Z, as price is presently breaking the $61 Lighthouse level. This
makes the bullish scenario more likely, as it becomes clear that we should now expect .
a (DD+) signal to form in the ascending channel. This will probably not occur at Points
A'-B', but may occur higher in the channel. There is nojustification to shortcrude oil at
this time because the hourly and daily pictures are bullish.

Walter J. Baeyens
Deatedwih T,odeS'''''''
From the (DD+) signal at Point D, the RSI continues up and is well over 40. The
moving averages are broken. Price breaks its 20-period moving average line to the
upside. If price manages to break the potential Neckline E-F, the picture becomes
bullish in the short-term. The RSI could be expected to continue up to Point Y, where a
(DD-) signal may form when the RSI reverses down and price does not exceed $74.
This means that the potential rally could carry from $62 to more than $70.
296

@Cl(D) · 60 mi1 NYMEJ( L·60.81 0.13 021% 8-60.81 A-60.90 0-60.12 H-81.80 Lo.6Q.S3 C-60.87 V",,32,720
58.00
1---/l--L...--'------:;?'"""""-----------:=¥-=-----------lS1.oo
58.00
5500
Feb 212 215 2; 2fT 2!8 219 2112 3 2114
The RSI action atPoints K and X does not indicate which channel the RSI is traveling.
The RSI tops pastPoint X seem to indicate that the descending channel is valid. Still, it
is clear that the RSIjumps into the next segment, following the (DD+) signal at Points
J-K. Consequently, we should see a new (DD+) signal forming on Line L-M, inside the
ascending channel. In this scenario, price should not drop below $59: the price level
corresponding to Point L in the RSI. Afterthe break-out from the wedge, price advances
further. The (DD-) Lighthouse at the $60 level provides support.
297

Walter 1. Baeyens
8-60.81 A-SO.� Q..6O.72 tt-61.BO lo�.53 Cs60.87 Y.132,720
- - -
- - -
-
-
The RSI manages to stay above its moving averages and advances toward Point Z.
There is still a valid (DD-) signal at Points X-Y, but the RSI is well above 40 and the
formation of a (DD+) signal could be expected at Points A'-B', or even at Point D',
within the ascending sub-channel 0' -B'-D'. This daily picture is turning bullish.
An RSI drop below Line O'-B'-D' would signal that the RSI is starting a down-leg to
the potential lower boundary Line 0'-C' of its ascending channel. It looks likely that
even in this scenario, price will not drop below Level A, [the Lighthouse level at $54 of
the potential (DD+) on the extended Line A'-B'].
The only bearish elements in this scenario are: 1) price reverses down from the (DD-)
Lighthouse level at $61 and 2) pricereachestheneckline ofa potential Head & Shoulders
pattern in the weekly chart.
298

@CL(O) . 6() min NYr;EX L-60.77 057 0.95% 8-6(l.76 A·6().76 o.6()26 f-i.6().99 Lo.sgE2 C·6().77 V-6,711
(DO·) 6().00
59.SO
59.00
5650
56.00
57.SO
57.00
90.00
60.00
70.00
6() 00
<D.OO
t===I==��==::::=:=�;:::;l30·00
20.00
10.00
2)5 2.Il 2" 2J6 219 2112 2113 2114 2M 2116 2"9 2120 2121 2122 2123 2126 2127 2126 Mar
riillJ
Deated will T,adeStal""
Line L-M is lowered to reflect the actual situation. The RSI reverses up from Point M,
forming a (DD+) signal in relation to Point L. The validity line forthis (DD+) signal and
potential ascending channel boundary is Line K-M. From here, we will need to see the
RSI move into the next segment at the arrow. If this fails, a further RSI drop to Line E
K is likely, where a (DD+) signal is due in relation to Point K (on the condition that price
will notbe lowerthan $58). Note how the boundaries ofthe mirroring channels converge
toward the RSI 50-level.
299

Walter 1. Baeyens
Aver.,0 58.20 57.62 51.04
(OD+) ? 58.00
58.00
5<.00
c 52.00
90.00
1---:::�-------====;:;--========+-;--:�:;;:f::::::=-_
_
_
_170.oo
20.00
fil m
Cleatedwill T,odoStolion
The RSI manages to stay above its 9-day simple moving average line and advances
slowly to Point Z. The longer the RSI stays up, moving sideways, the more likely it
becomes that a (DD+) signal is in themaking in the areaaround Point D'. The Lighthouse
level for the potential (DD+) at Point D' is at $57.30, forming a support level. Price
struggles at the $61 level, so the (DD-) signal must still be taken into account. The
effects ofthis (DD-) signal will only kick in when the RSI drops below Line 0'-B'-D'.
This takes usback to our strategy to short crude oil when price drops below $57 and the
RSI drops below Line O'-B'-D'.
300

1_ a.ro.80 A-OO.81 O-BO.2B �6039 Loz59.92
(00+)
2
iii
Created with T,odeSlotion
This is the fmal chart in ourcrude oil analysis. Prices struggle at $61 , which corresponds
to the potential neckline in this weekly picture. The RSI is above 40 and above both
moving average lines, but this is not the whole story.
Ifthe RSI continues down, a (DD-) signal will form in relation to Point F. Still, it is likely
that we will see the RSI decline to the point where its moving averages are about to
cross in the circled area. This could coincide with the formation ofa (DD+) signal in
the daily chart. If this daily (DD+) signal should take effect, we will see the weekly
RSI reverse up from the circled area. If a (DD-) signal shows up in the weekly time
frame, but there is valid (DD+) signal in the hourly, we will need to wait for the daily
(DD+) to be invalidated (with price dropping below $57) before the weekly (DD-) can
take effect.
301

Walter J. Baeyens
PART III
S&P 500 INDEX
Figure 5.88 Daily SPX (January 1 1 , 2007)
(The daily SPX chart is the same chart as Figure 3.36 in Chapter 3). The RSI bounces
nicely off its channel bottom, well above 40. The severe negative divergence (that
started in October 2006) does not harm the uptrend. It does cause a small dent in the
price advance as price breaks below the steep (DD+) support line.
If the RSI continues up, breaking out of its descending sub-channel at the arrow, an
advance to the RSI 80-level is in the cards. What would this mean for price? Look at
the price advance following the W-formation in the RSI in mid-August 2006. This W
formation is at the same RSI level that we are seeing now. The ensuing RSI rally to the
80-level late in October 2006 sees price move from 1 275 to 1 390! But we are not there
yet. Ifthe RSI break-out fails, we could see it drop to the Line A-C.
302

$SPX.X(O) - SO min COOE L.1423.00 -1623 -1.1J'l, 8=1423.74 A..1424.80 ().1440.31 �1440.69 lo-o1422.34 C..1423.90 V..O
1 ,440.00
1.430.00
1.
1 ,410.00
r---'-r-��--��------��-----------------I
1 .400.00
..-
__
__
__
__
__
-+-
__
__
---
,------f
__
"'9
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__
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__
__
__
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_r1 ,39l.oo
1 ,380.00
1 .370.00
10/31 1 1 m 11m 1UJ9 11�4 1 1 M 11121 11fl8 11130 12.1lS 12m 12�2 12�5 12120 12fl8 12fl8 1.0), 1.()9 1 � 1 1M 1 122 1125 1fl8 2C1
iIi
c,...ed Mh T,odeStotion
Figure 5.89 Hourly SPX (January 26, 2007)
After the RSI breaks from the Triangle Q-R, it fails to escape from its descending
channel twice, so the question remains open as to which channel is in force. If it is the
ascending channel, the RSI should build a (DD+) signal along the (DD+) reference line
in the vicinity ofthe circle. However, ifthe dashed line is broken, the RSI will enter
bearish territory as it drops to the 20-level at the bold line, the lower boundary ofthe
descending channel.
303

Walter J. Baeyens
XJ«D) . Oeiy COOE L-14233J ·1623 ·1 .13'JfO 8-1423.7< A-1424.� 001440.31 �.1440.69 L..1422.34 C.1423.91 V-O
Figure 5.90 Daily SPX (January 26, 2007)
1 .<100 00
��--------��--�I
1,350 00
1 ,300.00
40.00
30.00
We can see how important it is for the hourly RSI to stay within its ascending channel.
The RSI fails to break out at Point X, as discussed in the hourly chart. I have adjusted
the upper boundary ofthe descending sub-channel and its parallel lower edge to reflect
this.
The RSI is nearly touching Line A-B. Ifthe RSI drops below this channel boundary, it
will continue down within its descending sub-channel. There may still be a (DD+)
signal when it rebounds aroundthe 40-level, but a rise to the top ofits channel will only
take it to the 55-level, meaning a lower price high. Unless the RSI escapes from its
descending sub-channel, we will likely see a Head & Shoulders pattern in the price
chart.
304

J«O) · rwy CBOE l-1423.90 -1S.23 -1.13% 8-1423.14 A-1424.eo 0-1«0.31 11-1440.69 Lo-1422.� C-1423.90 V-o
Figure 5.91 Daily SPX with Candlesticks and RSI(3)
1,�.00
1,480.00
1 ,440.00
1,360.00
1 ,340.00
, ,320.00
1 ,300.00
SO.OO
30 00
20.00
Iil ill
Cleoled will TrodeSlotion
The tweezers-bearish engulfing candlesticks spell trouble, as this pattern is usually
followed by continued price weakness. The 3-period moving average of the RSI(3),
like the RSI(1 4), appears to be on its way to build a (DD+) signal in the rectangle area,
aroundthe 20-level.
30S

Walter 1. Baeyens
XJ«D) · 60 rni1 COOE L·'422.'8 ·1 .72 -0.12% 6-1421.89 A·1422.96 0-1423.90 H-142727 Lo-1416.96 C"" 22.18 VO{)
1 ,440.00
1 ,430.00
�
_
""
f-
-l-
-I
_
-----:
r
'---
_
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-----l
y
...:.:o:
=--
_
_
_
_
_
_
_
_11
1
410
.
00
1 ,400.00
r-
-----r---�+_��=---------------------r'�·oo
1,380.00
1 ,370.00
1,()1 1U)3 11AlB 11/10 11115 11120 11122 11/29 1W1 12.(l6 12111 12113 12118 12121 12/27 12129 1.c5 1110 1112 1118 1/23 1fl6 100 2m
Qeole<! will TlodeSlotion
Figure 5.92 Hourly SPX (January 27, 2007)
The RSI reverses up from the (DD+) reference Line S-T, while price stays nicely
above the (DD+) support line. The real test will take place when the RSI reaches the
dashed Line Q-T. If it reverses up from that line, the RSI will stay within the triangle
(forming between the dashed Line Q-T and the descending bold line).
This would mean that the RSI could get another chance to escape from its descending
channel, (which has failed twice). Ifthe RSI breaks below Line Q-T, this will correspond
in the daily chart to a violation ofthe important Line A-B-E, while an RSI break-out
means the RSI is escaping from its negative divergence channel. Decision time is
approaching. The hourly time frame will provide an early warning.
306

RSI: Logic, Signals & T
ime Frame Correlation
$SPX,X(D) - 60 nin CBOE L"1428.82 .8.20 +0.58% 8-1428.30 ,4,.1429.32 0-1420.61 Hi.1428.82 lo"1420.61 C.1428.82 VO{)
1 ,440.00
�
_
-,-
+-
_
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_
_
-=
"'=
_
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----J
�
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_
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_
1
1,410.00
1 ,400.00
1----,--,----:--1-----I:--:I---7�....-=---------------------- t'·
390
·
00
RSI Avereges () 57.33
1 ,300.00
1 ,370.00
-- -- � - -
- - - - - - l
00.00
40.00
- - - - �
11.08 1",3 11116 11120 11[24 11f29 12.04 12m 12m 1 2ft4 12119 12121 12/27 UJ3 1.()13 1110 1116 ",9 1123 1/26 1/31 2.Q5 207
Created Mh T,adeStation
Figure 5.93 Hourly SPX (January 3 1 , 2007)
The hourly SPX chart shows the latest price and RSI moves. The RSI continues up
while price advances modestly. As previously discussed, we will need to see the RSI
break out from its descending channel before we are convinced by the bulli�h elements.
A reversal down ofthe RSI into the Point T area still looks likely.
307

Walter J. Baeyens
XJ« D) - DoIy CBOE L-1428.82 <8.20 >ll.58% 8-1428.30 A-1429.32 0-1420.61 f;.'428.82 Lo-142O.61 C-1428.82 V-O
A
Figure 5_94 Daily SPX (January 3 1 , 2007)
1 ,400.00
��---------=�---=I
1 ,350.00
1 ,300.00
1 ,250.00
90.00
40.00
30.00
!&B
Created with TradeStatm
The RSI once again rebounds offLineA-B-E andprogresses into the narrowing triangle,
defined by Lines A-B-E and X-E. The negative divergence still holds, but the RSI
remains within bullish territory. We watch the hourly chart for an early indication of
which direction the RSI will escape.
308

$SPX)«(O) . 60 m CB()E L·1445.94 +7.70 +0.54% 9-1445.18 .1.-144623 0..1438.84 ti-1446.64 [0=1438.84 C.1445.94 V-o
1 ,4:11.00
1 ,420.00
1 ,410.00
r---��--��------��=----------------------I
1 ,400.00
1-
-:-----:--+----:-+-.!z��'------------------------t1 ,390.00
1 ,3ilO.00
1 �70.00
80.00
- - � 40.00
- - �:::==-.
r-
-
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- - - - - - - - - -
Q
11.oa 11M 11"5 11J20 11m 1 1 128 1201 12.00 12n1 12"3 12nB 12121 12/213 12129 1!l5 1"0 1"2 MB 1 /23 1125 1130 2m W7 209 l�:II
Created will TladeSt"""
Figure 5.95 Hourly SPX (February 2, 2007)
The RSI continues upward from the(DD+) reference line, enteringthe next RSI segment.
At the same time, the upper boundary ofits descending channel is being perforated at
the arrow. This means that Point T can be moved to the right, as it becomes clear that
the RSI is entering a higher segment. A good guess for the next (DD+) signal (within
the ascending channel) is at Line U-T.
309

Walter 1. Baeyens
XX(D) . DeIy caoe l-1445.94 .770 +054% &oH45.18 A-144623 0-1436.64 ti-1446.64 Lo-1436.84 C-1445.94 V-O
.---:-f---'lI-""'------=�11,400.00
1 ,350.00
1 ,300.00
90.00
00.00
40.00
3000
Figure 5.96 Daily SPX (February 2, 2007)
As discussed in the hourly chart, the RSI also challenges the upper boundary of its
channel. Ifthe RSI breaks out, our assumption will have to be that the only effect the
negative divergence has is that it allows the RSI to drop to a lower level within bullish
territory, only to create more headroom for a forceful price advance to new highs.
There is one caveat: the RSI break-out should not fail at this point. After a period of
negative price/RSI divergence, the RSI rebound often runsout ofsteam rapidly, reverses
downward, breaks the channel boundary and enters a vertical drop. The RSI must
break the 65-level soon. Had I discussed this pattern earlier in Chapter 2, I would have
labeled it the "Pull-up and Stall" pattern. Like an aircraft in flight, the RSI is in a dive
during the negative divergence phase. The recovery from the dive appears to bejust in
time as the RSI reverses up before entering bearish territory. However, the aircraft
(RSI) runs out ofspeed and stalls, losing altitude rapidly.
310

SSPX.X(D) .60min CBOE L-1446.99 ·1.40 -0.10% 8-1446.58 ,&,111447.49 0,,1446.28 H"'449.38 los1443.8S C=1446.99 V,.()
1 ,420.00
1 ,410.00
1 ,400.00
�
__
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Q
12.07 12112 12114 12115 12119 12121 12126 12128 1 .(13 1AJ5 1.()8 1110 1112 1117 1119 1123 1I.2S 1126 1130 W1 2.05 2.()7 2,09
1 ,360.00
fi1 m
Cleated w(h TradeStatoo
I have highlighted the ascending channel in the hourly SPX. At this point, we must
assume that this channel is in force now, since the RSI breaks from its descending
channel at the arrow. The formation ofa (DD+) signal is expected near Point T. These
are all bullish elements. Blue skies are ahead as long as the RSI stays above Line Q-T.
311

Walter J. Baeyens
XX(O) - 60 m CBOE L-H38.06 .10.25 .0.1'% 6-1437.55 .....,438.59 0-'448.71 ....1452.•5 Looo1 4;33."4 C-H38.06 V-o
1 ,450.00
1 ,445.00
1 ,42(UXl
1 ,415.00
1,410.00
� - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - �
1 1 12113 12115 12119
2.Ei 217 218 2J9 2113 5
iii W
Created wiIh T,MieSlation
The RSI drops to the area near Point T, as expected, but does not reverse up until
reaching the lower channel boundary Line Q-T. The expected (DD+) signal forms on
Line U-T at a slightly lower than anticipated level. The upward RSI reversal is not
quite convincing. We will need to see it continue in the next session. Ifnot, the RSI
could drop below Line Q-T.
312

RS/: Logic, Signals & Time Frame Correlation
$SPX.X(D) - Daiy CBOE L"1438.06 -10.25 -0.71% 8...,437.55 A..1438.59 0.-1448.71 1'1=1452.45 L0>'1433.44 0<1438.£J6 V.,O
1 ,420.00
.------c-1�-f--o"..-=----'=--'-----------11 ,400.00
1 ,380.00
1 ,360.00
1 ,340.00
1 ,320.00
1 ,300.00
��;��::=====::::::o�_
_
-
-
-
-
-
-
-
-
-
-
-
_
_
_
-
-[1 '200'OO
1 ,260.00
1 ,240.00
Oct
Figure 5.99 Daily SPX (February 1 0, 2007)
- - _ . - . - - - - - - - - - - - - - - - - - . - - - - - - - - - - - _ . " .
- - - - - _ . - - - - - - - - -
- - - - - - - - - - - - - - - - - - - - - - - - - - . - - - - - - • •-• • • • • . - . - • • • - - ---
C
so.oo
40.00
30.00
Iil
CreatedlIMn Tr!deSlation
Again, the daily RSI fails to break out decisively; it is unable to rise above 65. This
failure is significant, as it points to the "Pull-up and Stall." We need to closely monitor
the formation and effect ofthe potential (DD+) signal in the hourly chart.
313

Walter J. 8aeyens
12127 '07 1 I l lS 11ft 1116 M e 1
Figure 5.1 00 Hourly SPX (February 1 3, 2007)
1 ,450.00
1 ,••5.00
1 ,420.00
1 ,415.00
1 ,41 0 00
0.00
2f7 2� 2J9 21'13 2115
f.&J W
uealedwd1 TledeStaOOn
The RSI cannot seem to hold on to the lower boundary of its ascending channel. As
Point T is in bearish territory, price drifts lower each time the RSI reverses down. The
(DD+) signal at Points U-T still stands, but the RSI must reverse up in the next session.
314

$SPXX(D) - Doiy CBOE L-1433.37 -4.69 -0 33% EM 433.oo A-H34.G4 0-143794 ti001439.11 Loc14J1 .44 C-143J.37 '.1-0
1 ,420.00
�
d-
-I::;
7"""'
''--
--'=..:
'--'---
_
_
_
_
_
_
_ I,,400,oo
1 ,380.00
1 ,36000
1 ,340.00
1 ,320.00
1 ,3)) 00
1 ,28000
1 ,260.00
1 ,24000
90.00
,"00
c Xl.oo
��'=""=""=""'="'="'��------------------------I
Oct
ILW
ueated wth TladeSI5bon
Figure 5.101 Daily SPX (February 1 3, 2007)
The RSI tests Line A-B-E once again. As discussed previously in the hourly chart, a
reversal up is required to save the rally. Ifthis rebound occurs, we will need to determine
ifthe RSI succeeds in breaking above the 65-level.
315

Walter J. Baeyens
:x.xCD) -60min CBOE L-1444.26 10.89 0.76% e-'443.79 A-1444.68 0-1434.21 1f-1444.41 lo-1434.21 C-1444.26 V-O
1 ,450.00
1 ,440.00
1 ,435.00
,.-,c--------:--------,"""""-',........I"t--Ir/-------jf---------""""..-=c"---t1 ,430,00
1 ,425.00
1 ,420.00
1 ,415.00
1 ,410.00
1124 1126 1130 feb 212 2J5 2.6 2f7 2.e
Ct."ed wilh T,odeS'''''''
Figure 5.102 Hourly SPX (February 1 4, 2007)
As expected, the RSI bounces off its ascending channel bottom. The (DD+) signal is
confirmed atPoints U-T, but Point T is in bearish territory. We could potentially see the
formation ofa (DD-) signal, should the RSI fail to break out from its descending sub
channel in the ellipse.
316

SPX)((O) - Cleiy CBOE l-U«26 10.89 0.76% 8-1443.79 ....1444.68 0001·f3421 1i-1444.41 lo-1434.21 C-1«4,26 V-o
1 ,420.00
�
;-f-
--If::
7"""
=----
-=
'--'---_
_
_
_
_
_
_
I
, ,4oo.oo
1,300,00
1 ,360.00
1 ,340.00
1 ,320.00
1 ,:m.00
1 ,280.00
1 ,260.00
1 ,240.00
90.00
- - - - , - - - - - - -- - _ . - - - - -
. _ - - - - - - - - - . - - - - - - - - - - -
80.00
F=:..:.:..:.;�---------__=:::;;:;...-""""'::::=__:_l.IV<h__=;'f"_�----�D�----l70.00
E 50.00
'0.00
c 30.00
j--=-----=----=----=--·��-------------------------I
Oct
The RSI manages to stay out of trouble as it reverses upward from the Line A-B-E.
Let's see ifthe formation ofa (DD-) signal can be avoided in the hourly time frame.
317

Walter J. Baeyens
SPXJ«(D) . 60 min CBOE L-1455.:xJ i1 .a. 0.76% 8-1454.56 ,6.-1455.54 Qs144S.04 H-1457.65 Lo-144S.04 C-1455.30 V·O
1 ,450.00
1 ,445.00
1 ,440.00
1 ,435.00
1------:--------r-:lI!.L!.+-A1t-f,rf-+------=:-j-------b-�-----�l.•JO.OO
12/26 12126 '07 1 14 1.6 1.e 1,09 1111 1116 1fI8 1122 1 124 1126 1.00 Feb 2f2 2J5 2.6 2fl 2M 2B 2113 2115 2119
Figure 5.104 Hourly SPX (February 1 5, 2007)
1 ,42500
1 ,420.00
1 ,415.00
1 ,410.00
A bullish Fed announcement causes a rally. The RSI breaks its descending channel at
Point V, avoiding the formation ofa (DD-) signal and reaching the next chart segment.
The latest (DD+) signal takes effect. The RSI should stay within this segment and
produce another (DD+) signal on the dashed line, near the ellipse. An educated guess
for the origin ofthis projected (DD+) signal is at 1439. This means that in this tentative
bullish scenario, price will not drop below 1439.
318

SPX.X(O) ·'WeekIy CBOE l-145S.54 -1 .27 -0.1)9% B-14SS1» ,A.'456.00 0-1456.62 1f-1456.S2 L�1451.s7 V·O
3 I,hl
'I
,II
I 111'iI,I' 1 1111'
11,'11111"1 ' 1'1 ' II
ul'''lnrl
- - -
- - -
- - -
- - -
Figure 5.105 Weekly SPX (February 1 8, 2007)
,1Ii11111� 5?
1'1
1 ,40000
1 ,350.00
1,300.00
1,250.00
1 ,200.00
1,150.00
1 ,100.00
1 ,05000
2000
[jJ 0
Created will T,adeSlation
If the descending channel is considered a transition from one ascending channel to the
next, a projection of the new channel's lower boundary could be made by taking the
width ofthe previous ascending channel and plotting it in reference to the upperboundary
(dashed lines). However, in this scenario, we can assume that the RSI is not going to
break out of its descending channel.
I prefer this interpretation because it is compatible with a plausible Elliott Wave count.
There is also an RSI pattern that I have seen building only in weekly charts. Look at the
9-period simple moving average line in the RSI chart. In mid-2006, it moves up steeply
and levels off.
319

Walter J. Baeyens
Figure 5.1 06
1 . zoom-up
Figure 5.106
There is a pattern developing: In this imaginary RSI chart, the RSI is smoothed-out.
After a steep rise in Phase 1 , the RSI struggles to stay level in Phase 2 and attempts a
break-out. If it fails, the RSI will drop vertically. In the final stage of Phase 2, some
Doji-like candles typically develop and the price drop is swift and deep.
320

SPXJ<(O) - DsUy CBOE L-1451 .19 -5.19 -0.36% B-145O.83 ,1,-1451.62 0.1455.95 H-1455.95 Lo-1446.36 C·1 451.19 V-o
1 ,420.00
C--
-:+-
-I-:,
�
_
-'=-=--
-'-----
_
_
_
_
_
_
_11 ,400.00
c
Oct
1 ,380.00
1 ,360.00
1 ,340.00
1 ,32000
1 ,3((1.00
1 ,200.00
1 ,260.00
1 ,240.00
oom
The daily RSI reverses down from 65. Is an RSI Squeeze developing here? This is
certainly a scenario to take into account. The struggle the RSI has at the 65-level in the
daily chart is certainly not typical of a bull market. For the rally to resume, the RSI
needs to rise above 65. It looks like the RSI is about to test Line A-B-E again. The
hourly RSI should be monitored for an early indication ofa rebound or break-down.
321

Walter J. Baeyens
XX(D) . 60 mi'I CBOE l"1399.04 ·50.33 -3.47"- 8-1399.1)9 A-1400.82 0-1444.63 1iz1444.63 Lo:1389.42 C-1399.14 V-O
1 ,4&1.00
1,455.00
1 ,450.00
1 ,445.00
rf--'-'-------t-----=_"""'--�1 ,440.oo
1 ,435.00
1----,-------T"U>C.."c-jtf1--M�I__-__d_-----__:::b-�'-------_+-----f' ·430.oo
1 ,425.00
1 ,420.00
1 ,415.00
1,41 0 00
1------:=-'��---------------_+_------t__----fl.•
05.oo
'07 114 115 1.6 113 1111 1116 1 8 1122 In.. 1126 1m Feb 2f2 2J5 2E 2fl 2J8 2J9 2113 2115 2120 2 2fl6 Mar 312 3IS � 311
.00
Cre8.ed wth TladeStation
I could not have wished a better scenario to illustrate my Time Frame Correlation
method. Yesterday's bearish market action does not come as a surprise. We were on
the lookout for a test ofthe important Line A-B-E in the daily RSI.
We know from our earlier analysis there is a distinctive (but rare) pattern developing in
the weekly RSI. In the hourly chart, we conclude that another (DD+) signal is in the
making in the circled area. Ofcourse, the RSI needs to reverse up. The price Lighthouse
level for this potential (DD+) signal is 1 439. We know that ifthis price level breaks, this
potential (DD+) signal will never materialize.
It is also clearthat a drop ofthe hourly RSI below its ascending channel boundary Line
T-W will not only invalidate the recent (DD+) signal, but, more importantly, it will also
mean that the daily RSI is breaking below the equivalent Line A-B-E. In this case the
effect ofthe hourly RSI signal triggers a larger signal in the daily RSI and the daily RSI
behavior pushes the weekly RSI over the edge, as well. Hence, the huge and sudden
drop in price. This is a perfect illustration ofhow a "loose pebble" in the hourly RSI can
help us anticipate an "avalanche" in the weekly charts.
322

SSPX.X(D) - Deiv C8()E L"1399.04 -SO.33 -3.47% 8:01399.09 A..1400.82 0.,1444.63 Hi=1444.63 LD"'1389.42 C"'1399.14 V"O
Oct
1 ,460.00
1 ,440.00
1,420.00
1 ,300.00
1 ,360.00
1 ,�O.oo
1 ,320.00
1 �.00
1 )80.00
1 ,250.00
1 ,240.00
!Il.oo
fill]
C..ated with [radeSI"'"
In the pre-market ES (SPX) futures trading, it becomes clear that the daily RSI is going
to test Line A-B-E at the open ofthe regular session. I e-mailed a "Caution!" message
to my fellow traders, advising that a drop in the SPX (cash) below 1439 could trigger a
swift and deep sell-off. What a slide!
Note that the daily RSI even breaks below the channel boundary Line A-C, where we
expect a new (DD+) signal to form on the existing (DD+) reference line. Price drops
3.5% and nearly reaches the projected 1 390 level. In this case, it is a textbook Pull-up
and Stall pattern, as discussed earlier.
In fact, this market action is not unlike whatwe witnessed earlier in the NVDA analysis.
The recent rally is so strong that a (DD+) signal forms in relation to PointA, ifthe RSI
reverses up from the dashed line. But the RSI enters bearish territory and it has to be
assumed that the rebound will lead to the formation ofa (DD-) signal in the daily time
frame - the first one since July 2006!
323

Walter 1. Baeyens
Weekty cec:t: l-1399.04 -50.33 -3.47% e-1399.09 A-1400.82 0-1444.53 /i-1444.63 Lo-1389.42 Yo(I
3
- - -
- - -
- - -
- - -
- - -
Figure 5.110 Weekly SPX (February 28, 2007)
I conclude the SPX analysis with the weekly SPX chart. Note that this is an intra-week
chart, so the RSI picture does not reflect price action on close. Still, this chart illustrates
how brutal the sell-offcan be in this type ofRSI pattern.
I refer to the RSI pattern discussed on February 1 8. This pattern occurs twice in the
RSI charts ofthe Nikkei Index in 2006. On one occasion, the ensuing drop totals about
1 000 points, or nearly 7% ofthe index value. Although the weekly RSI travels within a
descending channel, the trend is still up and the recent (DD+) signal is still valid. Even
if the RSI drops all the way to the ellipse area, it will bottom near 40, where a new
(DD+) should form, as long as price has not dropped below 1 220 (Point 4).
A drop of this magnitude is unlikely. An acceptable scenario would be that the RSI
reverses upward into the rectangular area, where the moving averages are expected to
cross down. If the RSI reverses downward from this area, it could very well coincide
with the formation ofthe anticipated (DD-) signal in the daily chart. In this scenario, a
repeat ofthe RSI behavior from the period January to August 2004 could be seen.
Consequently, a price target of l 320 is not unrealistic, as this wouldmean the correction
extends to the previous Wave 4 area in my tentative Elliott Wave scenario. The key
elements in this scenario are: 1 ) the reversal down of the RSI when it reaches its
moving averages, possibly coinciding with a (DD-) signal in the daily time frame, and 2)
the failure ofthe RSI to stay above the nearest dashed line, (the potential lower boundary
ofa new ascending channel). After all, the highlighted descending channel could prove
324

to be a transition channel from one ascending channel into the next lower one, which
could take the RSI back to the 80-level and price to new highs.
The lower dashed line appears to have the bestchance ofbecoming the lowerboundary
ofthe future ascending channel because the width ofthis channel fits the size ofsuch a
channel. That is how this tentative line is plotted. In this scenario, when the RSI finally
reverses upward from the ellipse, we will have a giant (DD+) signal near 40 in an
ascending channel.
PART IV
NVIDIA (NVDA)
60mi"l NASDAQ l-38.65 ·(l.OS ·0.13% 6-38.26 A-O.OO o-euX) Ii-O.OO lo-o.OO C-38.70 V-O
Cleated �h TradeStation
Let's continue our study NVDA analysis from Chapter 4 (B, a). The RSI breaks the
triangle to the upside andbreaks the negative divergence. We can assume that the RSI
is traveling within an ascending ChanneF. At this point, the earlier reference lines are
irrelevant and can be deleted.
The corresponding price rally is explosive indeed. In the RSI, a FAST (DD+) forms on
the dotted triangle line and an ascending channel takes shape. In fact, the FAST (DD+)
forms as the RSI advances into the next segment, subsequent to the (DD+) in the
middle ofthe chart. We see the RSI build another (DD+) signal near the area bounded
by the rectangle. This means that corresponding prices are not lower than the FAST
(DD+) reference price at $37. Consequently, if a long position were entered, the $37
level would be a good location for a stop-loss order. The strong rally will remain
unchallenged as long as the RSI stays within its (smaller) ascending channel.
325

Walter 1. 8aeyens
Iiill
Cre¥ed � TradcSt�
Figure 5.112 Daily NVDA and RSI( 14)
The RSI( l 4) breaks out from its descending sub-channel, continuing to show negative
divergence at Point D and can be expected to continue up to the top of its descending
ChanneF. A mild downward correction is likely to cause a (DD+) signal at Point E
(shown by the rectangle in the hourly chart). Later, if the RSI manages to break the
larger scale negative divergence at Point F, it will signal that it is progressing within its
ascending Channel Y-Z-F. This would confirm the hypothesis that a new ascending
ChanneF started at Point A.
We will need to monitor RSI behavior in the Point E area, because LineA-E defines the
ascending sub-channel, and sooner or later, the RSI will start its down-leg inside a
descending sub-channel. Ifthe RSI manages to stay above Line Z-D-E, this may prove
to be the lower boundary ofthat sub-channel; significantly higher prices will be seen
before the RSI down-leg starts.
However, if the RSI drops below Line A-E too soon, a (DD+) signal should form in
reference to Point B, which corresponds to a price decline. The former scenario is now
more likely to unfold, given the RSI break-out at Point D.
326

A· DoIy NASDAQ L.38.65 '{)1l5 .{).13% 6038.26 AoO.oo 000.00 tioOOO L..o.oo C.38.70 Y-o
36.00
34.00
.
=-
_
_
_
_
_
_
_
--;-
-;-;;;I
�
'___7"'-----
-
-
-
-
-
-
-I32.oo
Figure 5.113 Daily NVDA with 3-day moving average of RSI(3)
3J.00
28.00
26.00
24.00
22.00
2fJ.00
18.00
100.00
2fJ00
1000
The RSI(3) confmns the RSI(1 4) picture. At Point D, the RSI breaks out from the
triangle that was defined earlier. The RSI reaches the 90-level but that does not mean
that the rally has to end. In fact, a rise in RSI value from 90 to 97 corresponds to
another strong price advance, while a small correction downward in price will send the
RSI(3) back to the 50-level.
327

Walter J. Baeyens
· 60 mil NASDAQ l-37.57 ...0.55 .1 .4s0.4 8..37.55 ....37.59 0-37.18 1i:a37.64 l0"'37.18 C-37.51 Y-4415953
35.00
:M.OO
33.00
32.00
3100
3000
29.00
�_
_
_
_
_
_
--::-
-::-
:::-
_
_
_
_
_
_
_
_
_
_
----::::::::::::=::===--=�-�OO.OO
1Il.00
70.00
�
V
�__��_��=��;::::..=JL-=��3��::::::::=---f40.00
w:
30.00
20.00
10.00
1 0111 1 0116 1 0119 10123 10126 10131 11m 111J7 11nD 11ns 11n7 11122 11128 121J1 121J6 121J8 12n3 12n8 12120 12128 12128 11J3 11lS
Cr...ed with T,adoS.....,
Afterthe FAST (DD+), the RSI drops back into the previous RSI segment andrebounds
offthe channel bottom, forming a (DD+) signal below 40. Price drops to the stop-loss
level at $37. If the RSI continues upward from here, the rally will resume, but the
formation ofa (DD-) signal is possible.
328

A· 60"" NASl)AQ L.37.00 -014 -0.64'10 &037.00 A.37.09 0.37.24 "'38.02 Lo.36.97 C.37D1 V06437738
0110 10ns 10119 10124 10126 10/31 1Ul3 1Ul7 11nO 11nS 11120 11122 11128 12�1 1Wi 12n1 12n3 12nB 12i21 12126 12129 Ul3 1m 21:30
38.00
35.00
34.00
33.00
32.00
31 .00
20 00
10.00
lim
Cleoledwill T.odeStolion
The RSI reverses down from 60, forming a (DD-) signaL Ifit breaks belowthe ascending
sub-channel, the (DD+) signal will be invalidated and the (DD-) signal will take effect.
Price is testing the $37 level again.
329

Walter 1. Baeyens
- 60 nil NASDAQ L-33.95 +0.04 +0.12% &>32.00 A-Ooo 0-0.00 ti=O.OO Lo-o.oo C-33.91 V-O
10113 10117 1 0J20 1 0J25 1 0130 11AJ1 11.('6 11.09 11113 1 1 116 11121 11127 1 1 00 12.Q4 12.(17 12112 1 2115 12119 12122 12128 1m 1.08 11'11 16:30
I.iiJ
Cre�edIIIiI:h TradeSt-"ion
After the formation of the (DD-) signal, the RSI breaks the channel bottom and the
(DD-) signal takes effect. Price breaks the $37 stop-loss level. The attempted rebound
at $35 is still a potential (DD+) signal, but price breaks this (DD+) support line as well.
The price drop exceeds 1 0% at this point!
The RSI is well withinbearish territory. Any rebound will likely causethe formation of
a new (DD-) signal in the ascending sub-channel defined by the most recent (DD-)
signal and LineA. There is some positive divergence building along LineA. Ifthe RSI
breaks Line A, we can expect it to drop to the dashed (DD+) reference line. The
Lighthouse level for this (DD+) is $3 1 .70. Ifthe positive divergence is broken, a realistic
price target will be $32.
330

HsO.OO Lo-o.oo C-34.SS v-o
A
5 11flO 11m 111"29 12()1 120) 12111 12113 12118 12/21 12m 12129 1.c5 1110 1112 1118 1123 1126
Createdwih Tf&deStation
On close, the RSI manages to stay above Line A. However, in the price chart, price hits
a low of$32.30 before bouncing back. The upward correction that follows takes price
to the underside ofthe triangle defined by (DD+) and (DD-) reference lines.
The RSI reverses down twice from the 60-level. Is an RSI Squeeze building at 60?
Will the RSI remain within its ascending sub-channel? The rectangle indicates where
the RSI could rebound, but there will not be a (DD+) signal at this point. If the RSI
breaks below Line A, price could fall to new lows.
331

Walter 1. Baeyens
A - Daly NASDAQ l-31.00 -0.24 -O.64'l. B-37.oo A-371)9 0-37.". 1i-38.02 lo-36.97 C-37.01 V-s.3n38
35.00
ll.oo
25.00
20.00
15.00
fillJ
D,"ed will T,odeS''''''
This shows the previous example, in the daily chart.
332

A - Daly NASOAQ L'�.12 -0.<13 -1.24% 8032.50 A�.86 O..().oo H-O.oo LO-O.oo Co34.55 V"()
30.00
20.00
15.00
A
Let's go backto theearlierFigure 4.22, in whichtwo scenarios are painted. It looks like
the bullish version is about to unfold as the RSI initiallybreaksthe negative divergence
Line Z-D. But price drops back from Point D, testing our stop-loss level at $37. We
previously discussed that the bearish scenario would unfold when the RSI broke below
Line B-E and the RSI would likely drop to the (DD+) reference line going through Point
B. In Figure 4.22, I labeled this potential target Point C.
The daily NVDA chart in Figure 5. 1 19 shows what happens next. The RSI breaks
below Line B-E and drops to the (DD+) reference line where it rebounds at Point G. In
the hourly time frame, this rebound causes the formation ofa (DD-) signal. In the daily
chart, Point G is not on the lower boundary ofthe ascending sub-channel, so another
decline is likely to form at this point. As the RSI is already in bearish territory, a slight
decline in the RSI corresponds to a significant price drop, so we can expect a new low
in price. This is in line with our earlier conclusion from studying the hourly charts.
333

Walter J. Baeyens
A - 60min NASDAQ La33D5 +0.17 +O.S2'l. B-32.BQ ,4,-33.83 0-0.00 H-O,OO Lo-o.OO C-32.88 V-O
/'
.,./ / B
_ ..- _
/' � �
/' � �
/' /' (00+' _ � - -
/'
� -
::::.-- - -- (OO+) LIGHTHOUSE
A' (DO+' ,
- - - - - - - - - �- - - - - - - - -
(DO+,
38.00
-.... --- -- __ - 37.00
-.... -.. - -
;:>--- - 36.00
36.00
3<.00
32.00
90.00
80.00
om 10131 1 U 12 11'()7 11110 11n5 11117 11122 11f.28 12,(M 12.03 12.00 12113 12118 12120 12126 12129 U)S us 1112 1118 1J22 1125 100 2.02
Dealed with TradeStaOOn
In the hourly time frame, we were anxious to see whether the RSI was goingto rebound
from the bottom ofits ascending sub-channel. The chart in Figure 5 . 1 20 shows exactly
whathappened
Notice the rectanglethatindicateswhere apotential RSIreboundcould occur, However,
the RSI continues down vertically to the (DD+) reference Line A'-B'-C'-D', The RSI
drop to Point D' was expected in case the RSI didnotrebound from the rectangle area,
Not surprisingly, this drop takes price down to the (DD+) Lighthouse level. This is
another example ofwhat happens when the RSI fails to break out. The price rebound
causes a new (DD-) signal and there is still the RSI Squeeze at the 60-level.
334

A· Daily NASDAQ l-33.05 +0.17 +0.58 B-32.SO '&"33.83 0-0.00 H-o.oo lo-O.OO C-32.88 V-o
15.00
Cleated .,.., T,adeStotion
Figure 5.121 Oaily NVOA
The price drop to the (00+) Lighthouse level in the hourly chart takes the RSI to the
channel bottom in the daily where it rebounds. From Point G, the RSI could continue up
to the Line Z-O-E, where a (00-) signal will likely form. Looking at price, a possible
textbook-scenario is certainly the resumption ofthe uptrend afterprice rebounds offthe
break-out level at $3 1 . For this to happen, we will need to see the RSI continue its leg
upward to 80, breaking above the Line Z-O-E.
When this fails and the hourly (00-) signal takes effect and the RSI breaks down
below its channel boundary Line A-G, what can we expect? If we look at where the
daily (00+) originates in the price chart and plot some potential (00+) reference lines,
we must come to the conclusion that a drop to the $25 area cannot be excluded when
price breaks below the $3 1 support level. The Lighthouse level for this daily (00+)
signal is $21 !
335

Walter J. Baeyens
A - [)ely NASD.....Q L-32.92 +O.Q04 +(J,12% 8-32.92 A-32.93 0.33.18 t-ti-33.30 lo-32.50 C-32.!l2 V.1379870
38.00
38.00
Figure 5.122 Daily NVDA with RSI(3)
This is the daily RSI(3) chart that was studied earlier in Figure 4. 14. Point D marks the
break-out of the RSI after the (DD+) signal, but the RSI drops back to the (DD+)
reference line. Point X is a good indicator ofwhat happened. Price breaks our stop
loss level at $37.
Point Z is well within bearish territory and the rebound causes the formation ofa first
(DD-) signal, which does not form in the RSI(l 4) ! So this picture provides us with
evidence that things may not be as clear-cut as they seem. Further evidence would be
the inability ofthe RSI(3) to rise above 80. A reversal down below 80, coinciding with
an initial (DD-) in the RSI(1 4), should make us very cautious.
336

A· _ NASOAQ l-33.05 .0.17 .0.52% 8>32.80 A-33.83 0-0.00 _.00 looOoo C-32.88 V-O
Averages () 52.77 62_58 6205
90.00
Cleated wih TradeSt"""
Figure 5_123 Weekly NVDA
The RSI is well within bullish territory. The trend is up and a (DD+) signal has formed,
so all is well. What could go wrong? The bearish scenario examined on the previous
page could take the following tum in the weekly chart:
The RSI rises to the circled area, where it hits the declining 9-period moving average
just below the bearish crossing point ofthe moving averages and reverses down. This
could coincide withthe formation ofa (DD-) signal in the daily chart. The ensuing RSI
drop should take the RSI to Point D, situated on the lower boundary of its ascending
ChanneF, around 40. If the RSI reverses up from Point D, the main (DD+) signal at
Point B will remain valid and the rally can resume.
If the RSI breaks below Line A-B-D, we can expect it to drop to the rectangle area,
which should correspond to $23. Initially, we will need to monitor whether the RSI will
be able to rise above its moving averages, which are crossing down overhead now.
337

Walter 1. Baeyens
A· Daiy NASDAQ l-32.68 0.16 0..-9% 8a31.00 ..11-35.91 0-0..00 H-OOO lo-O.OO v..o
38.00
(DD�
Oct U7
fiill
CleatedYiIh T.odeSlotion
Figure 5.124 Daily NVDA (February 22, 2007)
The daily timef
rame a
fter a f
ew weeks have passed. The RSI finally reverses up
from the area at Point G and pops up to Point E, where it reverses down. I have
adjusted the upper boundary ofthe descending sub-channel. This new RSI picture can
be summarized as follows: Within the descending sub-channel D-E-B-G, there is a
(DD-) signal at Point E (along the dotted line A-E) and, at the same time, there is a
(DD+) signal at Point G, which means that a triangle can be defined in the price chart.
We will see the RSI continue down to Line A-G, (the lower boundary ofthe ascending
channel), but ifthis line should be broken, we can anticipate a drop to Line B-G.
338

NASDAQ l-32.68 0.16 D.49'¥. 8-31.00 "'-35.91 �.OO tt-01XJ Lo-OOO V-O
(DO.)
Iil hE
Deae:ed wCh T,.-Station
Figure 5.125 Weekly NVDA
The RSI does not manage to rise to the anticipated moving average crossing point. The
RSI moving average crosses down (as shown by the arrow) and the RSI reversal
upward from Point E is not at all convincing. Still, there is a valid (DD+) signal at Points
C-E, but the bearish crossing of the moving averages indicates that the RSI will be
unable to stay above Line B-E. At this point, we must take into account that the RSI
may drop to Point D.

Walter J. Baeyens
Iil
Deated¥Mh T,ede$tebon
Figure 5.126 Weekly NVDA (March 1 , 2007)
This does not reflect the week's close. In this chart, the RSI is in the process of
invalidating the recent (DD+) signal at Points C-E. This comes as no surprise as a
(DD-) signal is detected in the daily chart.
340

• Doiy NASDAQ L-31 00 000 0.00'4 8-30.50 A-31 00 0-000 fio()OO L...oOO Y-330
3800
38.00
26.00
2400
, ')�:======�=-=122'00
�
20.00
Oct U7
Deotod wih T""IeSlaiion
Figure 5.127 Daily NVDA (March 1 , 2007)
The RSI moving averages cross downward in the daily chart as well as at the arrow. If
the RSI drops below Line A-G, the (DD-) signal will take effect and the RSI will likely
continue down to Point F, meaning a price drop to the $28 area.
341

APPENDIX 1 . REFERENCES AND RECOMMENDED READING
L'ANALYSE TECHNIQUE, Pratiques & Methodes (Economica, Paris, FR), by T.
Bechu, E. Bertrand
DAY TRADE FUTURES ONLINE (John Wiley & Sons, NY, USA), by Larry Williams
DIRECTACCESS FUTURES (John Wiley & Sons, NY, USA), by David 1. Silverman
THE 2 1 IRREFUTABLE TRUTHS OF TRADING (McGraw-Hill, NY, USA), by
John Hayden
MARKET MOMENTUM (McGraw-Hill, New York, USA), by Martin Pring
TECHNICAL ANALYSIS OF THE FINANCIAL MARKETS (Prentice Hall, NY,
USA), by John Murphy
JAPANESE CANDLESTICK CHARTING TECHNIQUES (NYIF, NY, USA), by
Steve Nison
RSI - THE COMPLETE GUIDE (Traders Press, Greenville, USA), by John Hayden
THE RSI EXPLAINED (Telerate Seminars, New Orleans, USA)- byAndrew Cardwell
NEW CONCEPTS IN TECHNICAL TRADING (Trend Research, McLeansville,
USA), by Welles Wilder
STREETSMART GUIDE TO TIMING THE STOCK MARKET (McGraw-Hill, NY,
USA)- by ColinAlexander
FOOLED BY RANDOMNESS (Thompson, NY, USA) - by Nassim N. Taleb
TECHNICAL ANALYSIS FOR THE TRADING PROFESSIONAL (McGraw-Hill,
NY, USA)-by Connie Brown
Websites:
BigCharts.com
TradeStation.com
All charts created on TradeStation®, flagshipproduct ofTradeStation Technologies, Inc.

APPENDIX 2. RSI MOVING AVERAGES FORMULA FOR
TRADESTATION
Display RSI(1 4) MovingAverages 9SMA and 45EMA in TradeStation using following
EasyLanguage formula:
Input: LENGTH( 14),PERIOD(9),PERIOD2(45);
Plotl (RSI(Close,14), "Plotl ");
Plot2 (Average((RSI(Close,1 4)),9), "Plot2");
Plot3 (XAverage((RSI(Close,1 4)),45), "Plot3");
After inserting the formula, have the system verify it. This is required, as TS will only
list verified (compatible) inputs.
Use the style and color features in the Format Analysis Technique function to hide or
highlight the RSI study (Plotl ) or either ofthe Moving Average lines (Plot 2, Plot 3).
Display RSI(3) Study and 3-period Moving Average using following EasyLanguage
formula:
Input: LENGTH(3),PERIOD(3);
Plotl (RSI(Close,3),"Plot1 ");
Plot2 (Average((RSI(Close,3)),3),"Plot2");

Symbols
(DDt),(DD-)
-what is? 62
14-period 17, 26
20-60range 26
3-period 37, 95, 208, 302
3MA, 3-period MovingAverage 329
40-80 Range 37
INDEX
45EMA, 45-period exponential MovingAverage 37, 208, 302
70/30rule 17, 26
9SMA , 9-period sirnple MovingAverage 37, 208, 302, 329
A
amplitude (price) 71
amplitude (RSI) 37, 71
anchor(ed) 37, 52, 193, 272
Arcsine (Law) 17
ascending channel
26, 52, 62, 71, 83, 95, 127, 135, 158, 169, 193, 208, 232, 252, 272, 302, 329, 337
ascending ChanneF 62, 83, 127, 158, 169, 193, 208, 232, 272, 329, 337
ascending ChanneP 52
avalanche 95, 329
B
bearterritory (RSI)
37, 52, 62, 71, 83, 95, 1 15, 127, 135, 158, 169, 208, 232, 252, 272, 302, 329, 337
behavior(price) 17, 52, 62, 71, 193
behavior(RSI) 17, 26, 37, 95, 1 27, 193, 329
and failure 1 1 5
in channels 52, 83
time frame specific 52
BG (BungeLtd) 52, 62
boundary, lower
52, 62, 71, 83, 95, 1 15, 127, 135, 158, 169, 193, 208, 232, 252, 272, 302, 329, 337
boundary, upper
52, 62, 71, 83, 95, 127, 135, 158, 169, 193, 208, 232, 252, 272, 302, 329, 337
Brown (Connie) 37
bull territory (RSI)
26, 37, 52, 62, 71, 83, 95, 1 15, 127, 135, 158, 169, 193, 232, 252, 272, 302, 329, 337
buy, sell signal (RSI)
what is? 37
c
Candlestick(s)
inside day 252
candlestick(s) 1 1 5, 193, 252
Cardwell (Andrew) 17, 26, 37, 52, 62, 95, 1 15

Cardwellian (signals) 52
channel(s)
sub-channel(s) 83, 95, 135, 1 58, 169, 193, 208, 232, 252, 302, 329, 337
ChanneF 52, 62, 83, 95, 127, 158, 169, 193, 208, 272
ChanneP 52, 62
conflicting (signals) 1 15
contradictory (signals) 1 7, 52, 71, 83, 1 15, 127, l 35, 1 58, 169, 193, 208, 232, 252, 302
correlate 17, 52, 1 15, 193, 208, 232
Correlation, Time Frame, (TFC) 17, 52, 71, 1 15
Crude (Oil) 158, 193, 272, 302
cryptology 17
Cup (and Handle) 62
CVD, Covance Inc. 193
D
descending channeI 52, 62, 71, 83, 95, 1 1 5, 127, 135, 158, 169, 193, 208, 232, 252, 272, 302, 329
descending ChanneF 83, 95, 158, 169
Disproportional Displacement(s) 37, 62, 95
distortion (RSn 52
divergence (negative) 26, 52, 62, 71, 83, 95, 1 15, 1 58, 1 69, 193, 208, 232, 272, 302, 329
divergence (peculiar) 37, 52
divergence (positive) 26, 62, 71, 83, 95, 1 15, 127, 135, 158, 169, 208, 232, 272, 302, 329
divergences, nature of 62
DTI, Dow Jones Industrial 95
Doji 193, 252, 329
DowJones Industrial Index (Dn) 95
down-leg (RSn 52, 135, 158, 169, 208, 252, 302, 329
DRG, Drug Index 232, 252, 272
E
earlywarning 17, 95, 135, 169, 232, 302
Elliott Wave 52, 62, 1 93, 329
engulfing 193, 252, 302
equation (RSn 1 7, 62, 95, 1 1 5
F
failure (DD+) 135
cause 169
significance 1 15
failure (price)
to reach target 1 1 5, 193
failure(RSn
means that 1 27
ofsignal 37
point 135, 1 69
to break below channel 83
to break down 83
to break-out 62, 71, 83, 1 15, 169, 329, 337
to drop into segment 83
to escape 302
to escape from channel 302
to exceed 80 232

tojump into segment 62, 232
to reach new highs 26
torise 60, 95
to stay in channel 169, 329
when? 52
failure (trend) 193
FAST(DD) 62, 71, 83, 95, 252, 329
Fed (Federal Reserve) 252, 272, 329
Fibonacci 26, 37, 52, 1 1 5, 193
futures 17, 95, 158, 193, 208, 272, 329
G
GM (General Motors) 26, 37
H
half-pipe(skater's) 17, 26, 37, 1 1 5
Handle (Cup and) 62
Hayden (John) 26, 37, 1 1 5
I
IBM 26, 37
indecision, pattern 26
INTEL (lNTC) 37
interpretation (RSI) 1 7
alternative 208
and Candlesticks 1 93
and failure-swing 26
and Fibonacci 1 93
avoid misinterpretation 208
CardweU 17, 26, 37
depth 52
flawed 1 7
in channels 17
in TFC 1 15
methodes) of 1 7
ofdivergences 26, 37
ofopposing signals 1 27, 135
ofRSI(3) 95
ofsignals 7 1
open questions 37
Wilder 17, 26
invalid(ity), signal 52, 83, 169, 232, 252, 272, 302, 329, 337
invalidate(d), signal 95
L
Lighthouse(RSI) 71, 83, 95, 1 1 5, 1 27, 135, 158, 169, 1 93, 208, 232, 252, 272, 302, 329, 337
logarithmic (RSI) 1 7, 52
logic (RSI-) 26, 95, 1 1 5
LRCX (Lam ResearchCorp) 37, 52, 71, 127, 1 69

M
mathematics (RSI)
equation 1 7
mathematical constraint(s) 1 7, 26
mathematical resistance 17, 26, 62, 127
vectormodel 127
missed target (price) 193
momentum 17, 26, 52
in divergence 62, 7 1
in TFC 95
increase in 26
relative 26, 62
required 37
MovingAverage (RSI) 37, 95, 193, 208
myths, old RSI 17
N
Nasdaq100, NDX 95
NDX, Nasdaq100 Index 95
neckline 62, 302
Nikkei(225 Index) 329
NKS (MerrillLynch) 83
NVDA(Nvidia) 208, 329, 337
o
Oil Index(OIX) 26, 37, 83, 135
OIX (Oil Index) 26, 135
opposing (signals) 1 27
out ofproportion 26, 37, 62, 7 1 , 95, 127, 1 35, 169, 272
overbought 17, 26, 52, 95, 1 15
oversold 17, 26, 52, 95, 1 15
p
pattern, candlestick 193, 302
pattern, Elliott Wave 193
pattern, price 193
Head & Shoulders 62, 302
triangle ) 35, 252
pattern, RSI 26, 83, 1 15, 127
M-shaped 37
Pull-up and Stall 329
RSI-Squeeze 95
triangle 26
W-shaped 252
Zoom-up & dive 329
period(RSI)
1 3-period signal 37
14 periods 17, 26, 1 15, 208

3-period 17, 208, 302
3-period signal 37
day 14, 62
look-back 17, 1 15
spread 37
period(s) (time) 17, 26, 37, 52, 62, 71, 95, 1 15, 193, 329
periods (EMA)
45-period 37
periods (SMA)
3-period 95
9-period 37
plot(ting) channel(s) 17, 95, 1 27, 208, 272, 337
pop-up (RSI) 26, 71, 95, 127, 232, 302
Pull-up and Stall,pattern 329
R
random(ness) (ly) 17
range-shift (RSI) 37, 52
Relative Strength (RS) 1 7
retracement(s), Fibonacci 193
grey area 193
using RSI ref. points 193
retracement(s), price
absence of 1 15
and Candlesticks 193
and RSI Lighthouse 169
causing a(DD) 169, 193, 232, 272, 302
deep 37, 52, 71, 95, 1 15, 127, 135, 158, 193, 208, 232, 272, 329
down 1 7, 37
in ElliottWave 193
inTFC 1 15, 127, 135, 158, 169
incomplete 83
shallow 37, 52, 62, 71, 83, 95, 1 15, 127, 135, 158, 1 69, 193
up 37, 52, 62, 272
reversal signal 62, 83, 95
risk/reward 17, 26
RSI Squeeze 95
RSI, myths 17
Russian Doll (aspect)
ofTFC, ElliottWave 1 93
RUT (Russell 2000) 62, 71, 193
s
S&P 500 (SPX) 17, 95, 158, 193, 302, 329
segment(RS1) 52, 62, 71, 83, 127, 135, 1 58, 169, 208, 232, 272, 302, 329
sell, buy, (RSI) signal
what is? 37
signal, (RSI)
buy: what is? 37
sell: what is? 37
slanted (reference lines) 26, 52
SOX (Semi-Conductor Index) 135, 193, 232
special case

of(DD) validity limit 83
Squeeze, RSI 71, 95, 127, 135, 158, 169, 232, 329, 337
stop-loss 26, 1 15, 169, 232, 272, 329, 337
strength, signal 95, 1 1 5, 193
T
and price trend 52
in vectors 1 1 5
what affects? 37
Taleb, Nassim N. 17
target(price) 17, 26, 37, 71, 83, 127, 158, 169, 193, 329
missed 193
target(RSn 37, 62, 71, 83, 95, 1 15, 127, 1 35, 158, 169, 193, 232, 252, 329
TFC (Time Frame Correlation) 1 15, 127, 158, 193, 272, 329
Time FrameCorrelation 1 7
timeframe-specific 52, 7 1
trend reversal 26, 37, 52, 83, 127, 1 58, 193, 208
triangle
in price 26, 127, 135, 232, 252, 272, 337
in RSI 26, 62, 83, 95, 127, 135, 232, 252, 272, 302, 329
indecision 62, 83, 95, 135
Tweezers 193, 252, 302
u
up-leg (RSJ) 52, 135
V
validity ofsignals 1 7
validity, signals 17, 26, 37, 52, 62, 71, 83, 95, 1 15, 1 27, 135, 158, 169, 208, 232, 252, 272, 302, 329,
337
special case 83
vector(s), RSI 1 1 5, 127, 135
w
warning 17
warning, when using RSI 17
wedge(s) 26, 62, 127, 135, 1 58, 272, 302
Wilder, (Welles) 17, 26, 37, 52, 1 15
z
zoom(ing) in, out 52, 1 1 5, 127, 208

About the Author
Walter J. Baeyens, a native ofBelgium, started pilot training in the Belgian Airforce at
age 1 8. By 1 975, he was flying supersonic F- I 04 Starfighters. He spent the last ten
years of his military career in international staffs in various NATO HQs in Germany
and Holland. After his retirement, he became a self-taught Intellectual Property
consultant, employing three people. An occasional options trader since 1 986, he made a
"direct hit" in the 1 987 stock market crash. In 2002, Mr. Baeyens sold his business and
turned his full attention to the study ofTechnical Analysis, and in particular, ofWelles
Wilder's Relative Strength Index (RSI).

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