A good place to begin to dispel some of the common beliefs about our technical indicators is with oscillators. The mainstream believe that oscillators generally travel between a scale of zero and 100. Generally 20 and below is viewed as oversold, and 80 or above is an overbought market. Wrong.
In figure 1.1 the standard default period of 14 is used for the Relative Strength Index with a daily bar chart of Yen futures. The Yen is falling in a bear market within this time horizon. The graph showing the RSI indicator has an upper black band marking a range of resistance from 60 to 65. A lower band marks 23 to 28 to highlight a support zone for the indicator. Study the indicator tops closely. At no time is the Yen strong enough to push the RSI oscillator successfully through the 65 level. (Spot traders need to keep in mind that this is a futures chart, which will be inverted from the spot market.) Each time the indicator tests the range from 55 to 65, the Yen renews its former downtrend and establishes new lows against the dollar. The oscillator then declines to a support zone within a range of 20 to 30. There will be many more examples to reinforce this concept. The general rule to follow for a bear market is that RSI will oscillate within a range of 20 to 30 at the low end of the scale up to an upper resistance zone of 55 to 65. This is true regardless of market or time horizon.
In a bull market the RSI will shift and begin to oscillate within a range marked by a support zone of 40 to 50 toward an upper resistance zone of 80 to 90. Figure 1-2 shows the same Yen futures market but over a weekly time horizon when the Yen is in a bull market or the dollar is weak. Each time the Yen declines, the oscillator falls to a support zone near 40 to 50. The 40 level is never broken. The strong Yen rallies push the oscillator into the 80s. Even minor advances that lead to more complex consolidations allow the RSI to decline only as far back as the 40 to 50 zone.
Do these RSI ranges defining bull and bear markets apply to other oscillators? Yes, when the period used for the indicator has benn correctly defined. We’ll cover how to find the correct period in the next chapter, and we will readdress the issue of buy and sell ranges as other oscillators are discussed. As an example, in Chapter 14 a price projection method is described for the Stockastics Oscillator that gives the trader permission to buy a market when the Stochastics Oscillator falls from an extreme high down toward the 75 area. Yes, buy, as the signal wil warn the trader that the market could target an additional move equal to the rally that preceded the minor pullback that allowed the indicator to decline from its extreme high over 80. This is only one example of instances when it would be incorrect to sell just because the Stochastics indicator has crossed the 80 range. Conversely a trader would have permission from Stochastics to sell the market when the oscillator moves back up to the 25 zone as the market would then target a new price low equal to the decline that precede the minor rebound from the oversold condition. Examplses for this price projection method from Stochastics will be offered in their right context in Chapter 14, but the point to make at this time is that oscillators can be used to forecast market trends, which is contrary to popular belief today.
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