BEARISH RSI BAMM

The Bearish RSI BAMM begins with a complex reading above 70. Referring to the RSI BAMM illustration in Figure 6.47, the entire process requires several elements to validate this specific scenario. Although the entire illustration might seem a bit overwhelming upon first examination, this represents the ideal RSI BAMM model. I recommend that you thoroughly study this material before employing these strategies in your live trading. Each step will be broken down to illustrate the ideal RSI BAMM model. Obviously, the ideal situation does not occur every time. It is important to remember that the real application of the RSI BAMM principles will require a degree of flexibility.

FIGURE 6.47

The ideal model does present all of the critical elements that clearly explain the effectiveness of this strategy. But, it will take a period of study to fully comprehend all aspects of the RSI BAMM approach. In much the same manner that the initial rules of harmonic pattern identification and differentiation may have seemed overwhelming, the RSI BAMM rules—albeit a bit complex upon first study—provide a coherent and comprehensive method for accurately measuring potential areas of divergence. Furthermore, it is essential to maintain the patience to execute only those trades that possess all required elements that validate a trade signal based upon the rules of the RSI BAMM setup. Again, it is important to remember that this illustration represents an ideal model and a framework to provide a set of guidelines that attempt to quantify precise technical events and to optimize overall trading decisions. However, the RSI BAMM strategy in combination with harmonic patterns effectively validates PRZs and improves the overall accuracy of the entire Harmonic Trading approach. The following example of the British Pound (versus the U.S. Dollar) clearly demonstrates these concepts.

BRITISH POUND/USD (GBP_A0-FX): WEEKLY

BEARISH RSI BAMM

The weekly chart of the British Pound in Figure 6.48 exemplifies the ideal RSI BAMM approach. It is important to study this chart as a model to distinguish and to validate RSI BAMM setups. This situation required more than a year to develop, but it possessed all of the necessary elements to establish the ultimate reversal at the RSI BAMM Confirmation Point on the weekly chart.

FIGURE 6.48

STEP 1: INITIAL RSI TEST OF EXTREME BEARISH LIMIT

In the Bearish RSI BAMM scenario, the first step is to identify price action that possesses an RSI reading in the extreme zone above 70. As I mentioned previously, the 70 level for the overbought limit, as well as the 30 level to define the oversold area, were first outlined by Welles Wilder in his book New Concepts and Trading Systems. In addition, a 14-period average is calculated from his approach.

STEP 2: COMPLETE A BEARISH M-TYPE COMPLEX RSI STRUCTURE

The initial focus should be on the formation of the indicator readings in the entire extreme overbought range rather than looking for a specific numeric level. As I outlined earlier in this chapter for the bullish scenario, it is important to differentiate the two types of indicator structures that form at RSI extremes.

TWO TYPES OF BEARISH INDICATOR STRUCTURES

In much the same vein as harmonic patterns, it is important to classify the general types of indicator structures that form in an overbought RSI area. Although each type could be assigned more specific classifications, indicator readings form either an impulsive or a complex structure. It has been my experience that most bearish RSI readings that are above 70 will be impulsive in nature and do not yield the required structure to be considered a valid setup. However, valid complex structures that are correctly identified offer a tremendous technical advantage because this situation is especially unique and represents a vital potential reversal area within the overall trend of the price action.

Sometimes, a complex RSI BAMM formation can be frustrating because the setup may not ideally unfold following the initial trigger. This can be particularly frustrating when a potential setup is followed for quite some time and fails to adhere to the RSI BAMM model. In the same manner that not all patterns form ideally, it is important to wait for only those situations that clearly provide all the required elements to validate the setup. Regardless, the primary focus of the initial step is to identify a complex the RSI BAMM M-type structure in the extreme area.

BEARISH IMPULSIVE INDICATOR STRUCTURES

A bearish impulsive indicator structure reflects price action that is experiencing a quick test of the extreme overbought resistance area, usually reversing quickly without any consolidating price action (see Figure 6.49). Since the price action commonly reverses sharply in these cases, the RSI rolls over and sinks below the 70 level typically within one or two price bars of the first overbought reading.

FIGURE 6.49

Although such impulsive formations may test the extreme bearish RSI level, it is important to focus on the nature of the indicator structure and not necessarily the exact numeric reading (as long as it is above the 70 limit). The exact indicator level is critical in quantifying the extreme state of RSI, but the general indicator formation is the critical factor, as it serves as the essential trigger to validate a potential trade opportunity.

Impulsive structures can be effective technical measures as they can serve to confirm bearish patterns and other trading signals. But it is important to note that the signals generated from extreme RSI readings do not constitute a comprehensive approach to trading the market. As mentioned previously, I believe that this is a common misconception for Relative Strength and most other technical indicators and oscillators. In my opinion, such technical measures must be utilized as a complementary methodology rather than as an exclusive approach. A Relative Strength reading above 70 does not automatically signify a trade opportunity. In fact, certain extreme impulse structures can signal significant continuations of the predominant trend. These strategies will be covered later in the book. For now, it is important to keep in mind the general types of structures. Furthermore, as is the case with all technical indicators, other methods must be employed to validate any potential trade opportunity on a multiple confirmation basis.

BRITISH POUND/USD (GBP_A0-FX): WEEKLY

BEARISH IMPULSE INDICATOR STRUCTURE   

Figure 6.50 shows the impulsive RSI in the British Pound that reversed sharply after exceeding the 70 level.

FIGURE 6.50

It is important to note how the price action stalled after testing the extreme overbought area. In this case, the price action reversed decidedly after the impulsive RSI test was completed.

BEARISH COMPLEX INDICATOR STRUCTURE

A complex structure represents an indicator formation that initially exceeds the 70 level and forms an M-type structure entirely in the extreme area (see Figure 6.51). The complex structure remains above the extreme 70 limit longer than an impulsive formation, and it should be distinct from other types of indicator readings.

FIGURE 6.51

Despite representing a more significant technical condition than an impulsive formation, the bearish complex structure is typically an early trading signal. In fact, it is common for price action to accelerate to the upside while the complex formation of the RSI reading completes. Furthermore, the initial reaction to the complex RSI structure may not seem to indicate a change in trend due to such strong price action. Despite this perceived strength, the validity of the entire RSI BAMM technique is not determined until the M-type structures has entirely formed in the overbought area above 70. Although the advanced concepts will be clearly presented later in this chapter, it is important to keep in mind that a complex indicator reading is merely the starting point for the entire approach not the defining event of the RSI BAMM methodology.

BRITISH POUND/USD (GBP_A0-FX): WEEKLY

BEARISH COMPLEX INDICATOR STRUCTURE

The example of a complex RSI structure in the British Pound shown in Figure 6.52 possessed all of the necessary elements to establish the RSI BAMM. As this chart example demonstrates, the initial test of the complex indicator formation typically experiences an acceleration of the predominant trend. Despite the perceived strength of the rally, the complex formation establishes the beginning of the most critical aspect of the entire RSI BAMM methodology—the divergence phase.

FIGURE 6.52

The bearish divergence occurs when the RSI reading weakens while the price action continues to rally. Although the price action may seem to be maintaining its current uptrend, valid complex RSI structures usually trigger a reversal sooner rather later and mark a critical area for a potential change in the overall direction. Although a few other elements must fall into place for the RSI BAMM to be validated, the complex RSI structure is the starting point for the entire process. Most important, this is an early signal, and it is critical to wait for the M-type structure to break under the 70 line. After the RSI formation has been completed, the other considerations of potential pattern completions and specific RSI BAMM harmonic measurements can be projected to determine the optimal reversal area. This leads us to our next step, which includes the defining and measuring of the price level that triggers this breakdown.

STEP 3: DEFINE THE RSI TRIGGER BAR

After defining the complex RSI formation, the next step requires a measurement of the price area where the M-type indicator structure has completed. The price bar that causes the complex RSI indicator reading to complete the M-type structure and to decline below the extreme 70 limit is known as the RSI BAMM Trigger Bar (see Figure 6.53).

FIGURE 6.53

After identifying the RSI BAMM Trigger Bar, it is critical to mark the top of this price bar by drawing an extended line from the peak, projecting the resistance to the right of the chart, as illustrated in Figure 6.53. This RSI BAMM Trigger Bar resistance level serves as a minimum technical area for the corresponding retest and the anticipated execution area of the completion of the final phase of the RSI BAMM. From a general perspective, the RSI BAMM Trigger Bar denotes the starting point for the critical divergence phase that the entire methodology is attempting to define and to quantify. Again, the completion of the complex RSI structure is only a starting point of the process. Although there are strategies that I will present later in this chapter to capitalize on the initial indicator breakdown, from a broader perspective the RSI Trigger Bar can reveal a great deal about the validity of the setup and the state of the potential price action. For now, the most critical element of the RSI BAMM approach begins after the indicator has reversed from the overbought reading by completing the complex M-type structure.

BRITISH POUND/USD (GBP_A0-FX): WEEKLY

BEARISH RSI BAMM TRIGGER BAR

The position of the Bearish RSI BAMM Trigger Bar in relation to the prior extreme high point is critical. Although its significance will be further explained later in this section, it is important to remember that the RSI BAMM Trigger Bar typically will be the price bar that is the prior peak of the current move or within a few intervals of the extreme high. This is critical, as the Trigger Bar’s position will determine the execution area for the corresponding retest and completion of the RSI BAMM.

The RSI BAMM Trigger Bar in the British Pound example in Figure 6.54 is clearly marked. After drawing a horizontal line to the right from the top of the Trigger Bar, the complex RSI structure defined the 1.8750 area as the first critical resistance level for the ultimate retest at the Confirmation Point.

FIGURE 6.54

STEP 4: REACTION OF RSI AND PRICE

After the Trigger Bar has been established, the initial reaction from the completion of the complex RSI structure and the price must be monitored closely. After topping out in the extreme overbought area above 70, the price action typically experiences a quick and decisive pullback. This is typically evidenced by a steady short-term downtrend (see Figure 6.55).

FIGURE 6.55

The critical divergence phase begins after this brief correction, which is normally marked by a breakout of the short-term downtrend line. This breakout is critical in defining the beginning of the divergence phase of the entire RSI BAMM methodology. Although I will review the other elements in more detail, this breakout typically will retest the RSI BAMM Trigger Bar area and rally to either a 1.13 or 1.618 extension while testing the extreme RSI overbought area above 70.

BRITISH POUND/USD (GBP_A0-FX): WEEKLY

REACTION OF RSI AND PRICE

After breaking out of the short-term downtrend line, the British Pound started to rally for the final divergence phase. The final rally included an impulsive retest of the 70 limit (see Figure 6.56).

FIGURE 6.56

As the RSI and the price react during this divergence phase, a few technical aspects must unfold to validate the final test and ultimate execution of the entire setup.

SPECIFIC TYPE OF RETEST

One of the most critical aspects of this divergence phase occurs during the initial reaction following the complex RSI structure completion. After the Trigger Bar has been established, the RSI reading MUST decline to at least the 50 level before completing the final divergence— where the price rallies while the RSI fails to exceed the readings established by the prior complex indicator formation. Although there is room for interpretation as the RSI reading may exceed the 50 level on this initial reaction, it serves as a minimum requirement that precedes the corresponding retest of the resistance area established by the RSI BAMM (see Figure 6.57).

FIGURE 6.57

Again, this specific type of retest offers other short-term trading opportunities that I will explain a bit later in this chapter. But, the important aspect of this element of the process is a minimum retest to the mid-point (50) level of the RSI. At this point in the RSI BAMM methodology, the price action typically declines fractionally while the indicator experiences a sharp correction. So, it is essential to focus on the indicator reading. After the mid-point 50 limit is tested, the final divergence phase of the entire approach will begin.

BRITISH POUND/USD (GBP_A0-FX): WEEKLY SPECIFIC TYPE OF RETEST: RSI MID-POINT (50 LIMIT) REQUIREMENT

Following the initial reaction after the complex RSI formation, the British Pound declined sharply in price and, more importantly, in the RSI reading (see Figure 6.58). Although the setup consolidated at the 50 line for several months, the eventual breakout from the initial downtrend line and the rally in the RSI marked the beginning of the final phase to complete the RSI BAMM Confirmation Point.

FIGURE 6.58

STEP 5: THE FINAL PHASE—DIVERGENCE OF RSI VERSUS PRICE

Figure 6.59 clearly shows the concept of this final divergence. As the RSI and the price retest their prior respective resistance points, they diverge in direction. As the RSI reading reverses after testing the 70 limit, the price action “spills over” the prior high in an attempt to continue the predominant trend. The “spillover” rally usually experiences a brief move above the prior high to either a 1.13 or 1.618 extension of the initial breakdown (X-A).

FIGURE 6.59

Later in this chapter, I will outline the rules that distinguish which harmonic projection works with the final divergence phase. But, the beauty of this technical phenomenon is that the breakout is inherently flawed due to the RSI failure, as the “internal strength” no longer supports the predominant trend. It is in situations like these where the general technical divergence between the RSI and the price offers tremendous trading opportunities.

BRITISH POUND/USD (GBP_A0-FX): WEEKLY

FINAL DIVERGENCE PHASE OF RSI VERSUS PRICE

The British Pound clearly exemplifies the ideal divergent technical situation. After completing the complex RSI structure, the price action rallied to a nominal new high (see Figure 6.60).

FIGURE 6.60

The secondary test of the RSI failed to exceed the prior reading. Moreover, the impulsive nature of the test further underscored the weakness, as the internal strength of the last rally barely penetrated the overbought limit above 70. The price bar that triggers the completion of the impulsive indicator retest is called the Bearish RSI BAMM Confirmation Bar.

BEARISH RSI BAMM CONFIRMATION BAR

The critical divergence between the price and the RSI can be seen in Figure 6.61. The RSI BAMM Confirmation Bar usually completes at either a 1.13 or a 1.618 extension of the prior decline and defines the divergence point for the entire setup. As the trend of the price action continues up (notice uptrend arrow), the RSI reading fails to continue higher, completing an impulsive structure that defines the RSI BAMM Confirmation Bar.

FIGURE 6.61

If the RSI Confirmation Bar is a valid resistance signal indicating a reversal at hand, typically the price action will decline quickly after exceeding the initial prior high level. Although I will outline the advantages of utilizing Harmonic Trading techniques of pattern recognition and Fibonacci measurement strategies with the RSI BAMM, it is important to examine this technical phenomenon on its own before trying to understand the advanced concepts. Most important, the simple divergence as marked by the Bearish RSI BAMM Confirmation Bar provides an effective technical situation that can be further refined with other trading strategies to define profitable opportunities.

BRITISH POUND/USD (GBP_A0-FX): WEEKLY

BEARISH RSI BAMM CONFIRMATION BAR

The illustration of the British Pound in Figure 6.62 clearly shows the divergence of the RSI versus the price.

FIGURE 6.62

The price action at the RSI BAMM Confirmation Point reveals a great deal about the strength of the predominant trend and defines the trading opportunity at hand. In essence, the divergent price action at the Confirmation Point rallies in a “last gasp” from the indicator reading. However, the extent of this “last gasp” must be determined, and specific harmonic measurement techniques provide the tools necessary to further refine these technical levels to define excellent trading opportunities.

REVIEW OF RSI AND PRICE

Before examining the final divergence stage, let’s review the steps for the RSI BAMM up to this point. The entire process started with a complex RSI structure. Following this completion, the divergence phase begins, as the RSI reading pulls back to at least the 50 level. After mid-level RSI check back, the price action breaks out of the short-term downtrend line of the initial reaction to initiate the final divergence phase (see Figure 6.63).

FIGURE 6.63

It is important to note that the entire RSI BAMM concept is encompassed within this retest of the resistance, as established by the top of the RSI BAMM Trigger Bar. Remember, this is a situation where the Relative Strength is providing an early signal to the end of the predominant trend. Although this signal may be the end of the trend technically, the price action usually experiences one last rally to retest the resistance area established by the complex RSI structure. When the price continues to rally as the RSI fails to exceed its prior resistance established by the complex reading, the final divergence phase has begun and the Confirmation Point is near completion.

BRITISH POUND/USD (GBP_A0-FX): WEEKLY

REACTION OF RSI AND PRICE

The British Pound example possesses all of the ideal elements and price action that encompasses the RSI BAMM methodology. Figure 6.64 illustrates all of the stages of the RSI divergence. However, the last phase of this approach employs advanced harmonic measurement techniques and other trading strategies to determine the validity of the setup and to quantify the price level for the entry of the trade.

FIGURE 6.64

Essentially, the various technical measurements are employed to determine an advanced PRZ, where both RSI BAMM projections and harmonic patterns complete. Although this may seem a bit complex upon first study, the overwhelming advantage of the combination of harmonic patterns at the completion of the RSI BAMM pinpoints critical technical levels and defines incredibly accurate trading opportunities.

STEP 6: BEARISH RSI BAMM CONFIRMATION POINT: 1.13 VERSUS 1.618

In the development of the RSI BAMM, I was challenged for quite some time to discern the correct extension to employ for the Confirmation Point. Although the difference between 1.13 and 1.618 may appear small, in real trading situations this gap frequently can be expensive. With respect to the primary tenets of Harmonic Trading and pattern identification, exact specification of these areas is critical in pinpointing the precise completion of the setup and in determining the validity of the overall trading opportunity. Although these are general rules, I noticed a difference in the RSI BAMM extension within the final divergence phase. These rules outline two areas—depending upon the position of the Trigger Bar relative to the prior high—to examine for a completion of the setup. If the RSI BAMM Trigger Bar is a few price bars (typically 2–4) from the prior high, the execution of the trade will occur at the corresponding 1.13 extension. However, an RSI BAMM Trigger Bar that develops at the extreme high for the move will result in a 1.618 extension at the Confirmation Point.

1.13 EXTENSION AT RSI BAMM CONFIRMATION POINT

Although the general rule regarding the Confirmation Point extension differentiates the 1.13 and 1.618 ratios, the focus of the Trigger Bar should be on the extreme prior peak. Essentially, if the RSI BAMM Trigger Bar is not the high price bar, the 1.13 extension is utilized to quantify the execution area for the trade (see Figure 6.65).

FIGURE 6.65

BRITISH POUND/USD (GBP_A0-FX): WEEKLY

1.13 EXTENSION AT RSI BAMM CONFIRMATION POINT

Referring to the British Pound example, Figure 6.66 shows an enlarged image of the RSI BAMM Trigger Bar. Again, the Trigger Bar is the price bar that results in the RSI reading falling under the extreme overbought 70 limit. In the case of the British Pound, the RSI BAMM Trigger Bar occurred three bars from the prior high. Therefore, the corresponding retest should possess a Confirmation Point that completes at or around the 1.13 extension of the prior initial reaction.

FIGURE 6.66

If the RSI BAMM Trigger Bar is the extreme high, the 1.618 extension would be projected to define the area where the Confirmation Point completes. I will show the 1.618 variation later in the chapter.

STEP 7: PATTERN COMPLETION AT THE RSI BAMM CONFIRMATION POINT

After establishing the necessary steps to define the final divergence phase of the RSI BAMM, the addition of harmonic pattern recognition techniques effectively complements the target execution area for the completion of the Confirmation Point. This integration immensely improves the accuracy of the Harmonic Trading techniques to quantify critical technical levels and to define profitable trading opportunities, as well.

From a general perspective, the integration of harmonic patterns at the Confirmation Point represents the most significant advancement of the entire Harmonic Trading methodology to date. Although I have discussed the importance of other technical strategies that complement the Harmonic Trading approach in prior books and articles, the application of advanced trading strategies such as the RSI BAMM takes this approach to a new level.

The additional specification of pattern identification within uniquely prescribed technical situations yields multiple confirmation signals. Such refinement improves the determination of pattern completions by placing stronger emphasis on the PRZ, as two separate measurement strategies yield the same result. When a variety of technical measurement tools yield the same result, the technical information being provided is typically more reliable and accurate.

In terms of the RSI BAMM, the Confirmation Point represents only one primary technical measurement. Albeit as a result of a rather complex sequence of technical events, the RSI BAMM Confirmation Bar defines more of a general price area than an exact range. However, the formation of distinct harmonic patterns within this price area represents powerful trade signals. In particular, a harmonic pattern at the RSI BAMM Completion Point frequently defines the precise execution area for a trade. In this manner, the extension at the RSI BAMM Confirmation Point serves as a minimum entry level before triggering a trade.

The importance of these two measurements will be analyzed in the following examples. Ideally, all of these technical events should complete simultaneously. Although some situations may not possess all of the ideal aspects of an RSI BAMM Confirmation Point and harmonic pattern completion, the integration of these techniques will effectively filter the best trades from the losers with tremendous accuracy. The following illustrations show the entire RSI BAMM methodology with various harmonic patterns at the Confirmation Point.