What is Adaptive RSI?

Traditionally, RSI is used as an underlay indicator to identify momentum on the price charts. But rather than using RSI for just momentum, we can modify the indicator slightly to use the indicator for not only momentum but for trend.

Adaptive RSI is an overlay indicator and is a modified version of the traditional RSI oscillator that can be used for Momentum and Trend. This indicator takes the traditional RSI indicator and factors in the price as well. The indicator is plotted as a line on the price chart

Interpreting the Adaptive RSI line

Adaptive RSI is plotted as a line on the price chart. Because the indicator factors in the price as well, it can be used for momentum and trend. There are three basic use cased of this indicator:

1. Rising line: This means the Trend is bullish and the momentum is also rising

2. Falling line: This means the Trend is bearish and the momentum is also rising but in the bearish direction.

3. Flat line: This means there is no trend or momentum.

But we need an objective method to define Rising, Falling, and Flat. When we use a single line, it is missing context. To add context, we can use the average of Adaptive RSI to bring context and objectiveness to the indicator. This gives a new interpretation to the indicator. The default value for the Adaptive RSI and its average is 14 period and 9 period respectively.

New interpretation for the indicator

When we add an average to the indicator, we get two lines on the chart. When there are two lines on the chart, we can use them line two Moving Averages on the chart. The new interpretation is:

1. Bullish crossover: When the Adaptive RSI line is above the Average line, the trend is bullish, and the momentum is also rising.

2. Bearish crossover: When the Adaptive RSI line is below the Average line, the trend is bearish, and the momentum is also rising in the bearish direction.

3. Flat lines or multiple crossovers: When both the lines are giving multiple crossovers within a range or is flat, we can conclude there is not trend or momentum.

A few Examples

Adaptive RSI can be used on OHLC charts, Renko charts, and Point & Figure charts as well. The timeframe can be intraday or swing or even positional.

Observe the P&F chart below of BSE on 1% (Daily). At point 1, the Adaptive RSI gave a bearish crossover when the Adaptive RSI line (Green) crossed below the Average line (Red). This showed a bearish trend and start of bearish momentum. At point 2, the bullish crossover signaled a bullish trend and start of a bullish trend. At point 3, both the lines went flat and the was a signal that the momentum was fading and the trend could be sideways.

Observe the OHLC chart below of ABREL. At point 1, the Adaptive RSI was in a bullish momentum and trend because the indicator was above the Average line. During this time, a pullback towards the Adaptive RSI line could be used to participate using pullback patterns. AT point 2, the lines showed fading momentum and sideways trend due to multiple crossovers and flat lines. At point 3, the price gave a breakout from this consolidation and continued the bullish trend.

Here is an exercise:

Before fully adopting an indicator, you need to backtest the indicator and understand how it works with your style of trading. You can do this exercise to test the indicator for yourself: Take 50 random stocks from the Nifty 500 index and plot this indicator. Observe the indicator’s behavior and try to understand how you could have participated or used this indicator.

Although this indicator can make trend and momentum analysis rather simple, it does not make a complete trading strategy. To participate in the strategy, we need to understand the patterns of the charting method to optimize the entry points. Also, we need to optimize the stock selection. No matter how good an indicator is, if it is plotted on the wrong instrument, it might not work. The right process of stock selection and patterns that can be used for various charting method is extensively covered in the courses How To Trade Candlestick, How To Trade Point & Figure, and How To Trade Renko, and Trade Markets Using Relative Strength. Do check them out using the link below for TNT One 👇