How to Determine Market Breakouts by Relative Strength Index (RSI)

After long periods of price appreciation, investors need to make their own intelligent judgment to decide what to do with the hefty profit.  They might take their bulky profit and leave the game anticipating the market may turn at the corner. Or, they might expect the well-founded direction to keep intact, and buy more securities at breakout.

However, it is challenging to determine if the new trend will emerge or the market will maintain the existing trading range.

To answer this tough question, the RSI might provide some insight, since it is capable of normalizing daily price data, and providing improved description about the actual price movements by smoothing the reading.

Here are some steps to distinguish the authentic versus fake breakout:

Step 1: If the RSI crosses over a 70 reading, and breaks resistance, the market or share price reaches a new high as well.  This might be a good indication for market breakout.  You might observe the market movement for a couple days to get confirmation.

     Chart 1: Dow Jones Industrial Average Index from 12/1/2012 to 8/1/2013

       Source: Line Graph Outline form StockCharts.com.  Actual data compiled by Authors.

 

Chart 1 displays that in December 2012, the market reached overbought status, and the RSI was over 70. After the market had consolidated for a while, the RSI reached 70 again, and passed the previous RSI reading. Moreover, the Dow Jones Industrial Average surpassed the previous level significantly, exceeding about 1,000 points. It was a positive indication of a breakout.  The market gained the momentum since then, and made a record high on 8/1/2013. 

Step 2: Usually in strong trending markets, the underlying securities might make a confirmation by pulling back slightly. Then you can watch: when prices fall back, if the RSI is holding up, and is higher than the previous RSI reading. 

          Step 3: Set a reasonable stop loss just in case of the false break-out, otherwise, enjoy the free ride for profit. 

         Credited to http://www.tradeology.com/rsimethod.html

          Dear Readers, what methods you use to determine the market breakouts? Thanks for your sharing!
 

          Have a great day.