BAMM Theory: Bullish RSI BAMM

BULLISH RSI BAMM

The Bullish RSI BAMM begins with a complex reading in an oversold area under the 30 limit. Referring to the RSI BAMM illustration in Figure 6.1, the entire process requires several elements to validate this specific scenario. 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.

FIGURE 6.1

Obviously, the ideal situation does not occur every time. It is important to remember that the real application of the RSI BAMM principles requires a degree of flexibility. However, the ideal model does present all of the critical elements that clearly explain the effectiveness of this strategy. 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 Bullish RSI BAMM setup.

Despite its initial complexity, the RSI BAMM strategy in combination with harmonic patterns effectively validates PRZs and offers an enhanced level of precision and accuracy.

CHEVRON-TEXACO (CVX): DAILY

BULLISH RSI BAMM

The example of Chevron-Texaco in Figure 6.2 shows an excellent RSI BAMM setup on the daily chart. Figure 6.2 does not display all of the critical details of the RSI BAMM; rather, the Chevron-Texaco chart manifests all of the basic elements to validate this setup.

FIGURE 6.2

This example of Chevron Texaco shows a distinct RSI BAMM setup. The initial complex RSI formation established the beginning of the entire process, and the indicator completed the necessary steps to validate the setup. Although I will outline the advanced concepts later in this chapter, it is important to review this chart carefully because it truly exemplifies all of the ideal elements of the RSI BAMM.

STEP 1: INITIAL RSI TEST OF EXTREME BULLISH LIMIT

In the Bullish RSI BAMM scenario, the first step is to identify price action that possesses an RSI reading in the extreme oversold zone below 30. As I mentioned previously, it is important to note that the 30 level for the oversold limit, as well as the 70 level to define the overbought 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. Although this system utilizes the standard RSI measures, the indicator can be refined to utilize other levels and time periods to define the extreme Relative Strength levels. I leave that to you to research. I have experimented with other periods, and these results have yielded excellent confirmation signals. In general, the standard parameters above a 70 reading as overbought and below the 30 limit as oversold with a 14-period average serve as the best guidelines for the entire RSI BAMM approach. Besides, who am I to disagree with Welles Wilder?

STEP 2: COMPLETE A BULLISH W-TYPE COMPLEX RSI STRUCTURE

One of the reasons why the RSI BAMM is so effective is because it requires that the entire structure of the indicator form below the oversold 30 level before a trade signal can be generated. This is advantageous because the RSI structure can be distinguished while still allowing for enough time for the price action to set up correctly to validate the entire technique. The initial focus should be on the formation of the indicator reading in the entire extreme range rather than looking for a specific numeric level.

This is a mandatory requirement of the RSI BAMM, where all points of the W-type formation must take place below the 30 level. It is important to remember that this is an early signal, and the price action quite frequently will continue in the predominant downtrend after the W-type structure has formed. But, this marks the initial stage of the divergence setup, where the price action continues lower, while the RSI stabilizes and begins to move higher. However, due to the variety of indicator structures that form in the oversold area, it is important to differentiate the two types that form at RSI extreme levels.

TWO TYPES OF BULLISH INDICATOR STRUCTURES

There are two general classes of W-type indicator structures that test the extreme oversold level—impulsive and complex. Most bullish indicator readings that are below 30 will be impulsive in nature and will not yield the required structure to be considered a valid RSI BAMM setup. However, valid complex structures that are correctly identified offer a tremendous technical advantage because they are particularly unique and represent a vital potential reversal area within the overall trend of the price action. The primary focus of the initial step is to identify a complex RSI W-type structure in the extreme oversold area under the 30-limit.

BULLISH IMPULSIVE INDICATOR STRUCTURES

A bullish impulsive indicator structure reflects price action that is experiencing a quick test of the extreme oversold support area, and it can typically reverse quickly without any consolidating price action (see Figure 6.3). Since the price action commonly reverses sharply in these cases, the indicator reading rallies above the extreme limit above 30 typically within 1 or 2 price bars of the initial test. 

FIGURE 6.3

Although such impulsive formations may test the extreme bullish 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 below the 30 limit). The exact indicator level is important in quantifying the extreme state of RSI, but the general indicator formation is the critical factor that serves as the essential trigger to validate a potential trade opportunity.

CHEVRON-TEXACO (CVX): DAILY

BULLISH IMPULSE INDICATOR STRUCTURE

In this example, Chevron-Texaco possessed an ideal impulsive structure (see Figure 6.4). It is important to note the sharp nature of the test of the extreme oversold area, as both the price action and the RSI reading reversed immediately after sinking below the 30 level.

FIGURE 6.5

Impulsive structures like these can be effective technical measures as they serve to confirm bullish patterns and other trading signals. However, it is important to note that the signals generated from extreme RSI readings do not constitute a comprehensive approach to trading the market. As I mentioned previously, I believe this is a common misconception in the application of the Relative Strength measure, and for that matter, 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 below the 30 limit 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 two different 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.

BULLISH COMPLEX INDICATOR STRUCTURE

A complex structure represents an indicator formation that initially exceeds the 30 level and forms a W-type pattern entirely in the extreme area, as illustrated in Figure 6.5. The complex structure typically remains below the oversold 30 limit longer than an impulsive formation.

FIGURE 6.5

Despite representing a more significant technical condition than an impulsive formation, the bullish complex structure is usually an early trading signal. In fact, it is common for price action to continue to decline sharply in price, while the complex RSI structure is developing in the oversold range under the 30 limit. 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 methodology. Furthermore, the complex formation establishes the beginning of the most critical aspect of the entire RSI BAMM methodology—divergence.

CHEVRON-TEXACO (CVX): DAILY

BULLISH COMPLEX INDICATOR STRUCTURE

The chart in Figure 6.6 shows an excellent complex RSI structure, as the stock formed a distinct W-type pattern in the extreme oversold area under the 30 level.

FIGURE 6.6

It is important to note that the critical divergence stage begins after the completion of the complex Relative Strength reading. After a period of consolidation, the indicator stabilizes while the price action continues to decline. Although the price action may seem to be maintaining its current downtrend, valid complex bullish RSI structures usually trigger a reversal sooner rather later. However, these structures mark critical support levels well before a potential change in the overall direction, but this situation typically requires a secondary retest before completing the reversal.

Although a few other elements must fall into place for the Bullish RSI BAMM to be validated, the formation of a complex RSI structure triggers the starting point for the entire process. Again, this is an early signal, and it is critical to wait for the W-type structure to break above the 30 line to confirm its completion. After the complex RSI structure has been established, 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 defining and measuring 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 W-type indicator structure has completed. The price bar that causes the bullish complex RSI indicator reading to complete and to rally above the oversold 30-limit is known as the RSI BAMM Trigger Bar.

After identifying the RSI BAMM Trigger Bar, it is critical to mark the bottom of this price bar by drawing an extended line from the low, projecting the minimum RSI BAMM support level to the right of the chart (as is illustrated in Figure 6.7). This RSI BAMM Trigger Bar support line serves as a minimum technical level for the corresponding retest and the anticipated execution area of the completion of the final phase of the RSI BAMM.

FIGURE 6.7

CHEVRON-TEXACO (CVX): DAILY

RSI BAMM TRIGGER BAR

From a general perspective, the trigger bar as defined by the completion of the complex RSI structure denotes the starting point for the critical divergence phase that the entire methodology is attempting to define and quantify (see Figure 6.8).

FIGURE 6.8

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 oversold area by completing a complex W-type structure.

The position of the Bullish RSI BAMM Trigger Bar in relation to the prior extreme low point is critical. Although its significance will be further explained later in this section, it is important to remember that the Bullish RSI BAMM Trigger Bar typically will be the price bar that is the exact prior low of the current move or within a few intervals of the extreme low. The trigger bar is critical because it marks the completion point of the complex RSI structure. In essence, it is the price bar that completed the W-type structure and rallied the indicator reading above the oversold 30 level to generate a significant technical signal.

STEP 4: REACTION OF RSI AND PRICE

After the initial pop following the completion of the complex RSI structure, the price and indicator begin to decline in tandem (see Figure 6.9). Frequently, this initial breakdown offers a distinct trading opportunity, but these strategies will be covered a bit later in this chapter. However, the initial breakdown still requires a few elements to be satisfied to realize the completion of the RSI BAMM.

FIGURE 6.9

CHEVRON-TEXACO (CVX): DAILY

REACTION OF RSI AND PRICE

After the RSI BAMM Trigger Bar has been established and the price action rallies following its completion, there will typically be a breakdown of this brief and sharp rally. In the case of Chevron-Texaco, the price action rallied sharply—establishing the first phase. After completing the RSI BAMM Trigger Bar, the price action and indicator reading began to roll over immediately after violating the brief yet sharp uptrend line (see Figure 6.10).

FIGURE 6.10

In all cases, when the price action rolls over after violating the uptrend line following the RSI BAMM Trigger Bar completion, the final phase of the entire RSI BAMM process begins. However, there is one condition for the initial reaction following the completion of the complex RSI indicator structure. This specific type of retest is a mandatory condition before the final stage of the RSI BAMM completion can be realized.

SPECIFIC TYPE OF RSI RETEST

This specific type of retest is one of the most critical aspects of the entire RSI BAMM methodology. The RSI reading MUST retrace to at least the 50 level before the final retest can occur (see Figure 6.11).

FIGURE 6.11

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 to distinguish the most ideal situations. The mid-point retracement for the RSI reading is an important intermediate step that precedes the corresponding retest and the final phase of the RSI BAMM. This condition serves as a sufficient correction of the initial extreme RSI reading before establishing the final divergence. Let’s look at the Chevron-Texaco example to illustrate this mandatory retest.

CHEVRON-TEXACO (CVX): DAILY

RSI BAMM TRIGGER BAR

In the Chevron-Texaco example, the stock tested the minimum mid-point RSI line on the initial reaction after the completion of the complex RSI structure (SEE FIGURE 6.12). Although the stock required time to consolidate at this midpoint line before testing the Confirmation Point, the fact that it tested the mid-point line served as the minimum requirement to validate the RSI BAMM.

FIGURE 6.12

Again, it is important to note that the indicator reading may exceed the 50 level, but it must test this area at a minimum before completing the RSI BAMM Confirmation Point. In this example, Chevron-Texaco began to roll over after the first test of the RSI mid-point level but still required a period of time before resolving the divergent technical situation.

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

The final divergence stage begins after the RSI reading pulls back to at least the 50 mid-line. The short-term rally breaks down from the uptrend line of the initial reaction. The rollover of the initial rally leads to an eventual retest of the prior low. The price action and the RSI reading retest their relative prior support points in tandem. (The horizontal [dotted] line drawn from the low of the RSI Trigger Bar to the right of the chart defines the minimum resistance level for the completion of the RSI BAMM and the eventual entry of the trade [see Figure 6.13].) The important technical information of the entire approach is revealed in this retest. The best trading opportunities develop when distinct patterns complete at important retest points for the RSI. When patterns complete while the RSI stabilizes, these signs accurately validate successful reversals well in advance.

 

FIGURE 6.13

This is a situation where the Relative Strength reading 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 typically experiences one last decline to retest the support area, as established by the complex Bullish RSI structure. This final stage of the retest reveals a great deal about the strength of the predominant trend and the validity of the signal generated by the complex RSI structure. In essence, the price action diverges in a “last gasp” from the indicator reading.

CHEVRON-TEXACO (CVX): DAILY

DIVERGENCE OF RSI VERSUS PRICE

After Chevron-Texaco completed its reaction following the complex RSI BAMM structure, the final divergence stage was initiated. Clearly, the price action started to decline while the RSI reading stabilized (see Figure 6.14).

FIGURE 6.14

On the retest of the complex RSI structure, the ability of the indicator to test the extreme area while holding above the prior reading manifested the internal strength of this reversal zone. The price action rolled over to nominally sink below the prior low and retested the oversold area with an impulsive RSI structure.

This type of technical action is a perfect example of the RSI BAMM defining a critical divergence area. In fact, the phenomenon of this technical divergence is the most critical aspect of the entire methodology. Important clues and signals occur within this stage of the approach to validate these setups. Specifically, the price action should exceed the prior low nominally, while the RSI reverses above its prior reading and forming an impulsive retest of the oversold 30 limit. The critical point of the divergence can be seen in Figure 6.15 where the trend of the price action continues slightly lower while the trend of the RSI reading moves higher.

FIGURE 6.15

This final stage of the entire setup reveals the extent of divergence, where the Relative Strength reading of the trend indicates a reversal hand while the price continues to decline in a final dip. If the RSI structure is a valid support signal, typically the price action will reverse quickly after exceeding the initial prior low point. Although I will outline the advantages of utilizing Harmonic Trading techniques of pattern recognition and Fibonacci measurement strategies with the RSI BAMM Completion Point, it is important to examine this general technical phenomenon on its own.

This phase of the RSI BAMM defines the specific type of divergence that Welles Wilder described in his book New Concepts in Technical Trading Systems. However, the final phase of the RSI BAMM employs advanced strategies that refine this divergence to define unique and incredibly accurate trade opportunities. Specifically, pattern formations that converge with the RSI BAMM Confirmation phase offer remarkably important technical evidence of the state of the predominant trend and future probable direction.

CHEVRON-TEXACO (CVX): DAILY

BEARISH RSI BAMM CONFIRMATION BAR

The enlarged chart in Figure 6.16 shows the bullish divergence between the RSI and the price. Clearly, the RSI stabilized as Chevron-Texaco declined to a nominal new low. After reversing from the RSI retest, the RSI BAMM Confirmation Point was completed and the reversal was triggered.

FIGURE 6.16

STEP 6: BULLISH 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 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 technical measurement techniques is required to yield the most accurate information regarding the validity of any trading opportunity. Although these are general rules, I noticed a unique variation in the ultimate extension of the final divergence phase of the Bullish RSI BAMM.

The key factor depended upon the position of the Trigger Bar relative to the prior low. If the RSI BAMM Trigger Bar is a few price bars (typically 2–4) from the prior low, the execution of the trade will occur at the corresponding 1.13 extension. However, an RSI BAMM Trigger Bar that develops at the extreme low for the move will result in a 1.618 extension at the Confirmation Point.

As mentioned previously, the technical divergence that occurs in this step is the most important part of the entire approach because it gauges the price action at a critical “internal” point within the trend. Although the RSI BAMM structure may form in the indicator and indicate internal strength, the retest where the reading has stabilized and the price action has diverged offers an enormous amount of information regarding the technical state of the overall trend. Specifically, when the price declines below the initial low as the indicator reverses from an impulsive test of the oversold 30 limit, the Confirmation Point serves as a critical support level. Furthermore, this area validates the existence of any bullish patterns converging at either a 1.13 or a 1.618 extension. Although I will discuss the importance of pattern completions a bit later in this section, the prescribed RSI BAMM projection points define a precise technical window for a potential reversal. In combination with harmonic pattern recognition techniques, these methods complement each other immensely to pinpoint precise make-or-break technical levels. Simply stated, the key is to look for a harmonic pattern that completes in the same area and at the same time as the RSI BAMM Confirmation Bar. For now, it is important to review the basic rules for the measurement of the projected divergence—either 1.13 or 1.618—before discussing pattern completions in the final phase of the RSI BAMM.

1.13 EXTENSION AT BULLISH 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 low. Essentially, if the Bullish RSI BAMM Trigger Bar is not the extreme price bar from the prior low, the 1.13 extension is utilized to quantify the minimum execution area for the trade. Typically, the RSI BAMM Trigger Bar that employs a 1.13 extension is either the third or fourth price bar from the extreme prior low. Without question, an extreme low price bar that comprises the RSI BAMM Trigger Bar will utilize a 1.618 extension. However, the 1.13 extension is merely a critical minimum price level at the RSI BAMM Confirmation Point (see Figure 6.17).

FIGURE 6.17

The completion of harmonic patterns may influence the ultimate execution point of the trade beyond the minimum target of the Confirmation Point in the case of a 1.13 extension. For example, a Bullish Butterfly may form in the final divergence leg and complete at a 1.27 projection, slightly past the 1.13 extension of the RSI BAMM Confirmation Point. In this situation, the completion of the harmonic pattern would be more significant and serve as the entry level for the trade. Although a test of the 1.13 extension should always be a minimum requirement for a trade to be triggered at the RSI BAMM Confirmation Point, the completion of a harmonic pattern in this area possesses greater significance and more distinct technical price levels to determine the validity of a potential trade.

CHEVRON-TEXACO (CVX): DAILY

BULLISH RSI BAMM TRIGGER BAR

In the Chevron-Texaco example shown in Figure 6.18, the RSI BAMM Trigger Bar is the third bar from the prior low. In these cases, the typical RSI BAMM Confirmation Point occurs at the 1.13 extension. Although there is room for interpretation, this example of the Chevron-Texaco shows an ideal situation.

FIGURE 6.18

Unlike the case of the 1.618 extension, any situation that is not the extreme low will normally employ a 1.13 extension as the minimum RSI BAMM Completion Point.

STEP 7: TRADE EXECUTION AT THE BULLISH PATTERN COMPLETION AND THE BULLISH RSI BAMM CONFIRMATION POINT

After establishing the necessary steps to define the final divergence phase of the Bullish RSI BAMM, the integration of harmonic patterns at the Confirmation Point represents the ultimate advancement of the entire Harmonic Trading methodology. Although the RSI BAMM Confirmation Point is generally differentiated by the location of the Trigger Bar as it relates to the prior low, the execution of the trade is defined by the completion of a distinct harmonic pattern in the PRZ.

The combination of these two methods in this manner yields precise levels of harmonic support and accurate entry levels for potential trades. However, there are a few important scenarios that must be regarded, as to know which patterns are to be applied to the appropriate RSI BAMM scenario. The primary focus should determine whether the RSI BAMM Confirmation Point will end at a 1.13 or a 1.618 extension.