Here’s what you should know about the True Strength Index TSI indicator
A quick overview of the True Strength Index
Have you heard about True Strength Index or TSI? Well, this indicator is extremely helpful when it comes to determining oversold and overbought trade conditions. This acts as a momentum oscillator and notifies you about potential trend direction movements. These trend direction changes can happen either via signal line crossovers or centerline crossovers. TSI provides you a strong warning when there are chances of trend weaknesses through divergence.
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How does True Strength Index work?
In the previous sections, you have already learned about a quick overview of TSI. Let’s now understand how it works. This indicator is mostly used in order to identify both overbought and oversold trade conditions. These overbought and oversold trade conditions can happen when there is a change in any of the available asset prices, trend direction, and spot divergence via the centerline crossovers. In all of these situations, TSI will alert you about a possible overbought as well as an oversold condition.
What’s more, the True Strength Index TSI indicator will further help you highlight and detect short-term price momentum conditions via signal line crossovers. Thus, you can clearly understand that the TSI indicator is mainly based on the price movements. Due to this, its detection process for identifying oversold and overbought trade levels varies a lot based on the asset you’re trading. For instance, different assets have different types of reversal rates. Some stocks may offer +30 and -30 price reversal rates. Whereas, some stocks may offer a price reversal rate between +20 and -20.
If you can carefully follow these price reversal changes and identify extreme TSI levels, you will be able to easily and quickly spot out overbought and oversold trade situations. If there are oversold trade situations, it does not necessarily mean that it’s the ideal time to buy. Similarly, an overbought trade situation doesn’t completely mean that it’s the right time to sell. Rather, these situations help the traders to analyze the market moves and take the trade decisions accordingly. Typically, the traders watch for some other signals before triggering a trade decision.
Sometimes, the traders will check for the price or TSI parameter to drop their values before selling an overbought asset condition. Some traders even wait for the signal line crossovers before taking the trade decisions. Let’s now talk about the signal line crossovers and centerline crossovers.
Signal line crossovers
True Strength Index indicator typically has a signal line. The crossover situation happens when the TSI line passes through the signal line. There can be two scenarios in this case.
For example, if the TSI line passes through the signal line from the above, this indicates the situation of short selling or warrant selling. On the contrary, if the TSI line passes through the signal line from the below, this implies the situation of a long position.
Kindly note, signal line crossovers are quite frequent. Hence, please feel free to utilize it in conjunction with the original TSI signal and other available signals. For your quick reference, buy signal cases happen when the TSI line is above the centerline/zero position. Similarly, the sell signal cases happen when the TSI line is in the overbought territory.
Apart from the signal line crossovers, TSI generates one more crossover that is alternatively known as the centerline crossover. This centerline crossover will also help you to find out when the price momentum indicates a positive sign and when it’s negative. When the indicator lies above zero, the price momentum shows positive. Similarly, the price momentum becomes negative when the indicator lies below zero. Many traders use this centerline crossover for identifying a directional bias situation.
For example, traders like you may consider a long position situation when the TSI indicator value is just above the centerline. Likewise, a trader may consider a short position when the indicator remains below zero/centerline.
Breakouts and divergence
True Strength Index TSI indicator can even help the traders to identify price momentum shifts as well as breakouts. For example, when the TSI indicator lies below a trendline, there are chances of continued selling.
TSI index provides a wealth of information including resistance levels and divergence. Divergence is indeed an effective and efficient tool for traders. Luckily, this TSI or True Strength Index can help you determine the scenarios of bearish divergence and bullish divergence.
Consider an example, when the asset price is moving higher and the TSI index has dropped its value, this situation will be a bearish divergence. In bearish divergence, you will observe downside price movements. Similarly, when the TSI index is rising its value and price is falling, this will lead to bullish divergence.
Please note that divergence should be used along with some other signal parameters generated by the TSI value index or any other technical indicators.
TSI vs MACD
These two indicators may have the same trading purpose, but their calculation procedure is totally different. TSI price changes form a technical oscillator. However, the MACD indicator measures the separation between two available moving averages.
How can you calculate TSI value?
TSI = (PCDS/APCDS) x 100
Here, PCDS is denoted as a 13-period EMA value of PCS (EMA is exponential price average and PCS is price change smoothened value). APCDS is denoted as 13-period EMA value of APCS (APCS is absolute price change smoothened value)
For calculating the TSI index and its value, you will need to figure out price changes & absolute price changes. Next, you will calculate EMA values for both these two values. Now, you should find out 25-period EMA for price change value and 25-period EMA for absolute price change value.
You can further smoothen up these two values and find out PCDS and APCDS. Once you have found out APCDS and PCDS, you can easily calculate TSI.
Limitations of the True Strength Index TSI indicator
There are some limitations to this signal that you should note. First of all, it tends to generate false signals. Secondly, signal line crossover situations occur so frequently that you may not receive any trading benefit as such. Divergence is also unreliable at times.
Considering the above limitations, you are recommended to combine TSI results with other methods of analysis and technical indicators for the best outcomes.