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When it comes to Elliott Waves, how do you use the momentum indicator (RSI)?

When it comes to Elliott Waves, how do you use the momentum indicator (RSI)?
When it comes to Elliott Waves, how do you use the momentum indicator (RSI)?


There are a variety of momentum indicators to choose from. The RSI (Relative Strength Index), created by J. Welles Wilder, who died in 1978, is one of the most well-known authors. The RSI is represented as an oscillator with a range of 0 to 100. According to conventional wisdom, an RSI of 70 or higher indicates an overbought state. Meanwhile, an RSI of 30 or below implies that the market is oversold. Elliott Wave Theory, on the other hand, is a separate type of technical analysis created by Ralph Nelson Elliott in the 1930s, far earlier than the RSI. It analyses price patterns and structures to determine investor emotions and psychology, as well as forecast future trends.The idea finds a five-wave impulse that establishes a trend. Corrective waves, on the other hand, form in three waves in opposition to the greater trend. Since Elliott Wave Theory predates the RSI, there was no connection between the two systems when they were first used.

Elliott Wave Forecast (EWF), as one of the major service providers, discovers a new approach to integrate RSI with Elliott Wave. We don't use it to determine if a stock is overbought or oversold. The following are the RSI guidelines we employ at EWF, and how they differ from the usual understanding:

In Elliott Wave Theory, the third wave is usually the most powerful. In a bullish market, the RSI of wave 3 frequently remains in the overbought zone (>70). Traditional interpretations of RSI say that if it exceeds 70, it is overbought, and traders should sell it. We do not, however, advise selling wave 3. In fact, an extended period of RSI above 70 indicates that the trend is in that direction, thus buying the dips is preferable to trying to select the peak and selling.

In Elliott Wave Theory, Wave 5 is characterised by momentum divergence. Price makes a higher high while momentum (RSI) hits a lower high in a bullish market. Momentum divergence, according to conventional wisdom, indicates that the instrument is bearish and may sell off. However, in our opinion, a momentum divergence in an uptrend indicates that the prevailing trend is positive, as the divergence occurs in wave 5, which defines the trend's direction.As a result, even if the instrument can pullback in three waves following the conclusion of wave 5, if the overall trend is bullish, it's preferable to purchase the dips than to choose the peak and sell wave 5.

In a seven-swing structure, a divergence also occurs in the fifth swing. A double correction, or WXY, is a swing structure with seven swings. When the internal of waves W and Y are both zigzags, it's referred to be a double zigzag. The fifth swing in a seven-swing double-three structure should have a divergence, as seen in the graph below:

Three-fold structure

Three-fold structure
Three-fold structure



Swing #5 should arrive with momentum divergence, as shown in the graph above, when the structure creates a 5 swing lower. In other words, the price makes a lower low at that point, while the RSI produces a greater low. A bullish reading of a momentum divergence like this is based on the traditional view. Even if we expect the instrument to rise in swing #6, the fact that there is a divergence in swing #5 implies the general trend to the downside is not yet complete.Thus, rather than attempting to purchase the divergence, it is preferable to sell the rally, as the prevailing trend in this case is to the negative, as shown by the end 7 swing structure. Every corrective structure, whether it's a 3 swing ABC or a 7 swing WXY, should conclude without a divergence, according to the guidelines.

We utilise RSI divergence at EWF to see if the instrument is in wave 5. We also use it to see if the structure is a 7 swing structure that isn't complete. If an instrument, for example, eliminates divergence, we may need to change the count and no longer refer to it as wave 5. In this example, an instrument might be in wave 3 with extended wave 3 or a nest. These are just a few of the ways we employ RSI in Elliott Wave analysis.



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