The True Strength Index (TSI) offers a unique approach to technical analysis for traders. A momentum oscillator, the True Strength Index helps to define directional trends, reduces ‘noise’ in the market and generates trading signals that will allow you to profit from both positive and negative price trends.
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In this guide, you’ll learn more about this useful indicator, including:
- What the True Strength Index
- How to use it
- Advantages and disadvantages
What Is The True Strength Index?
The True Strength Index (TSI) is a technical indicator and momentum oscillator used by traders to define directional trends and overbought/oversold levels. The indicator uses moving averages that display changes in market price to help reduce market noise and generate trading signals.
Trading strategies that use the True Strength Index were originally developed by William Blau in 1991 as a way of defining the differences between overbought market conditions and oversold market conditions. In modern day 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. As a result, the True Strength Index is actually a combination of two different technical analysis techniques that can be used to make predictions about future trends in market prices.
How To Use True Strength Index
True Strength Index readings are used primarily to identify market conditions where an asset’s price has become overbought or oversold. This momentum oscillator can also give traders emerging clues about new trend directions through divergences.
- Readings are bullish when the True Strength Index shows positive values
- Readings are bearish when the indicator displays negative values.
It is important to understand the pivotal role that is played by the centerline in the total trading analysis. Readings oscillate through positive and negative values and it is the centerline that determines the stance or outlook for those looking to execute trading positions.
Readings in the True Strength Index are ultimately based on movements or changes in the market’s underlying price action, so different asset classes might experience small variations in the ways the oscillator reacts to changes in order flow.
Some asset classes might see values in the True Strength Index reach -30 or +30 before major price reversals can be expected, while other asset classes might not see significant price reversals until reaching the -20 or +20 threshold.
In the chart example above, we can see how the True Strength Index signals an upcoming bull trend in the market. The upward slope of the True Strength Index suggests that a bullish trend is beginning and traders would be able to enter into long positions in this asset after the positive signal has been generated.
In the next chart example, we can see how the True Strength Index signals an upcoming bear trend in the market. The downward slope of the True Strength Index suggests that a bearish trend is beginning and traders would be able to enter into short positions in this asset after the negative signal has been generated:
Crossovers through the center-line are somewhat infrequent and this means the True Strength Index offers trading entries that are much more conservatively timed (when compared to other well-known oscillators used in technical analysis).
Readings in the True Strength Index are also unique because they tend to track market prices with a high level of consistency. This often makes the True Strength Index most interesting for this involved with trend-following strategies.
The True Strength Index presents a number of advantages for traders:
- Readings tend to follow market prices remarkably well
- Incredibly useful way of assessing overbought or oversold valuation conditions in the market
- It also produces technical analysis signals that indicate the end of a trend when divergences are present relative to market prices
- The limited number of total trading signals is appealing to conservative traders
However, there are some potential drawback to be aware of:
- It can produce false signals, which means that trends in price fail to match expectations after the indicator suggests a specific trade outlook (bullish or bearish)
- Values can also change direction without underlying changes in market prices
- Additional technical analysis indicators or price chart patterns are required to protect against false signals
We’ve summarised some key points below to take away with you about this indicator:
- True Strength Index readings oscillate based on positive and negative values.
- Positive values suggest that market bulls control the dominant trend. Negative values suggest that market bears control the dominant trend.
- Divergences with the market’s underlying price activity suggest that the dominant trend is ready to reverse.
- Long trades can be taken when the True Strength Index suggests bullish trend activity (upward price movements).
- Short trades can be taken when the True Strength Index suggests bearish trend activity (downward price movements)