This Previously Reliable Signal Looks Set To Flash Again

In trading, there are very few reliable technical signals, especially when it comes to predicting longer-term moves. Long-term shifts in direction usually come about due to fundamental changes in supply and demand, so past price action, the basis of technical analysis, is not a very reliable indicator. Some, though, are more reliable than others, and over the last two years there has been one signal for crude futures that has been worth watching. I wrote about it a few weeks ago, and is now close to being triggered for the fifth time in that period. It has been right, to varying degrees on all four previous occasions.

That signal is Relative Strength Index (RSI), or rather a slightly modified version of it.

RSI measures the strength of moves up and down in price over a given number of time periods. You don’t really need to know exactly how it is calculated, although if you do the information can be found here. Suffice it to say that it results in a number between 0 and 100 and that there are two signal lines, at 30 and 70. Crossing below 30 is considered to represent an oversold state, and therefore signals a buy, while above 70 signals the opposite.

Like all technical analysis, the biggest problem with RSI is that it can easily give false signals. That tendency can be reduced by looking for two successive crosses of the line and waiting to see a return to the “normal” band before acting. Then, if that fails take a small loss and if there is a third cross and re-entry, try again. That has happened, as I said, four times over the last two years, marked on the chart below by arrows on the lower plot.

As you can see, each of those times, the multiple cross of the signal line and retracement have immediately preceded a significant reversal of direction. The least successful was at the beginning of last year, but even then, oil dropped around fifteen percent before bouncing back.

All of that is significant now because, after briefly crossing the line on March 20th then returning, RSI has re-crossed recently. Yesterday’s drop took us very close to the point where it returns below the line again which would, using the method outlined above, be considered a sell signal.

The fact that we are trading a bit higher this morning has delayed that, but it does serve to illustrate an important point about any signal-based trading over longer timespans…It is important to wait for confirmation before acting. The potential rewards are large enough that missing out on a few points by waiting is not a big deal. On that basis, yesterday’s brief return to a reading of below 70 would not have been enough to trigger a trade. If we move lower again however, and RSI holds below the level for a couple of days it will be.

As mentioned at the outset, there are no infallible signals. If, for example, there is a resolution to the U.S./China trade dispute in the next few days, and/or if the jump in U.S. inventories that sparked yesterday’s selloff turns out to be an anomaly, then we will move higher, no matter what the chart says. That makes it important that any trade triggered by a signal is managed properly, with realistic stop-loss levels that are adhered to. With that important proviso though, if you follow crude, now would be a good time to add RSI to your chart and watch for a confirmed move lower as a sell signal.