One of the keys to forex trading is effective use of various technical indicators that allow you to analyse market movements. One such trading tool is the True Strength Index (TSI). In modern day forex technical analysis, the True Strength Index is based on Moving Averages that help to determine underlying momentum levels for specific assets. The numeric values that are generated by Moving Averages are considered to be lagging indicators, yet momentum readings are traditionally leading indicators.
What is the True Strength Index indicator?
True Strength Index (TSI) is a double-smoothed momentum indicator. The indicator in this case turns out smoother, since sharp and minor changes are not taken into account.
The True Strength Index has three parts: the double smoothed price change, the double smoothed absolute price change, and the True Strength Index formula.
The TSI also uses the signal line – EMA, while the trend itself is determined quite simply:
- If the TSI is above the signal line, then the uptrend is expected;
- If the TSI is below the signal line, then the downtrend is expected.
In theory, price can range from 0 to infinity. However, the indicator of the True Strength Index ranges from -100 to +100. As a rule, the trend changes when it reaches its extreme value.
The example shows that when the price reaches +25, only two outcomes are possible. The trend can stop at this level or may go down. Thus, the True Strength Index is used not only to determine the trend movement, but also to find the extreme of a trend.
Calculation of True Strength Index indicator
The formula of the True Strength Indicator is as follows:
- EMA – exponential moving average;
- Momentum – the difference between today’s and yesterday’s closing prices;
- N – the number of periods used for smoothing (usually a value of 25);
- N – the number of periods used to smooth out a smoothed valuable moment (value 13).
For some, the formula of the indicator of True Strength Index may seem unusually complex, but for using it in your day to day forex trading it is not necessary to be an outstanding mathematician. It is enough just to correctly understand the values and apply the indicator to your charts.
How to use True Strength Index indicator?
The indicator is used to spot overbought and oversold conditions in an asset’s price point, identify the direction of the trend and changes through the centerline, spot out divergence, and highlight short-term price momentum with signal line crossovers.
The priority component of the indicator is the twice smoothed momentum. This allows you to remove unnecessary noise and can help to more clearly determine the price movement.
The main advantage of using the True Strength Index is the timely display of zero level. This allows the trader to conclude a trade according to the current trend direction.
It is important not only learn to determine the trend, but also to find the best prices for opening a position. That is, with a growing trend, we want to buy an asset, and then sell it at the highest possible price.
True Strength Index trading strategy
There are several different ways to interpret the meaning of the true strength index indicator. In technical analysis, traders can use it to help determine the direction of the market’s trend. Additionally, the TSI indicator can be used to gauge the strength of the trend. Lastly, it can provide signals of an imminent reversal that may develop.
If the signals are interpreted correctly, traders can use the TSI indicator to enter new forex trades or exit current ones.
We can use the SMA (100 period) along with the True Strength Index indicator to find potential buy and sell trading signals.
True Strength Index buy strategy
- Wait for the TSI to cross the zero level.
- The TSI line should cross the SMA (100 period).
- We can buy an asset once a bullish candle appears.
- We can place stop-loss slightly below the swing area.
- We can exit the trade in profit once the TSI goes back to zero level.
True Strength Index sell strategy
- Wait for the TSI to cross the zero level.
- The TSI line should cross the SMA (100 period).
- We can buy an asset once a bullish candle appears.
- We can place stop-loss slightly below the swing area.
- We can exit the trade in profit once the TSI goes back to zero level.
True Strength Index conclusion
The True Strength Index (TSI) is a momentum oscillator that was proposed by William Blau. He wrote about it in the then-popular Stocks & Commodities Magazine. As with other oscillators, the TSI can be used to identify trading signals.
Most traders use it to identify potential oversold and overbought levels. Others use it to find centreline crossovers while others use it to identify bullish and bearish divergencies.
When it is applied on a chart, the TSI has three lines. The horizontal line is known as the zero line while the other two are known as the plots. These two are the ones that provide signals to traders.
The basic principles for using the True Strength Index are described above. You can use the tool as a forex trading strategy or you can even use it as a confirmation tool. Moreover, the best part of this indicator is its function to determine when the trend gets exhausted.
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