Using the RSI to help pick a long entry point

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In this section, Figure 12-1 provides a solid example of the type of situation that calls for using the RSI in combination with a bullish reversal pattern. This chart is from Applied Materials (AMAT), which is a very large technology company that creates machinery used to manufacture semiconductors. The free-wheeling, rock 'n' rollin', throw-caution-to-the-wind experts in this industry refer to it as the semiconductor equipment industry.

A three inside up reversal pattern appears after a couple of bearish days, during a short-lived downtrend. (Check out Chapter 9 for more on the three inside up pattern.) The RSI helps confirm that the candlestick pattern is sound because the RSI closes under 30 on the pattern's first day. That means that the stock is oversold if the standard oversold level 30 is being used, and bullish buyers will soon be on the scene to drive up the price of the stock.

Figure 12-1:

combination of the RSI and a three inside up pattern on a chart of AMAT.

Figure 12-1:

combination of the RSI and a three inside up pattern on a chart of AMAT.

The last two days of a three inside up pattern are bullish days. Bullish behavior generally means that the RSI is moving out of the oversold level. Consider RSI levels over the course of a pattern, not just on one of the pattern's days.

Bullish reversal patterns like the three inside up usually end with bullish moves, so it would be pretty rare to find an RSI reading under 30 (or whatever level you consider oversold), at the end of a pattern.

It's also worth mentioning that some traders use the RSI to buy when it goes below the oversold level and then moves back above this level. That move is more important to them than the simple act of the RSI dipping below the oversold level, and they use it as confirmation that the trend has reversed.

On the AMAT chart in Figure 12-1, the trend definitely reverses on the three inside up pattern combined with an RSI reading under 30. The result is an uptrend that lasts for a few weeks but never quite reaches the overbought level. If you watch a stock and see a bullish trend reversal candlestick pattern that coincides with an oversold reading on the stock's RSI, buy and look for an uptrend to dominate the chart soon.

I offer one more example of how you can use the RSI in combination with a bullish reversal pattern in Figure 12-2. This figure features a chart of the stock for Amazon (AMZN). The RSI on the chart in Figure 12-2 spends some time trading around the oversold level of 30, dipping below and then rising above that level on two different occasions. What's the difference between these two instances? The second (and successful) move was accompanied by a bullish reversal pattern.

Figure 12-2:

An RSI and trend reversal pattern indicate where to buy on a chart of AMZN.

Figure 12-2:

An RSI and trend reversal pattern indicate where to buy on a chart of AMZN.

A bullish three outside up pattern (refer to Chapter 9 for details) appears on this chart at a time when the RSI closes under 30 and then rises over the oversold level. The resulting move is an uptrend that lasts a couple of weeks and then rolls over. If you spot those developments and quickly establish a long position, ride the uptrend for a while and then trade out when things start heading south. The result is a nice quick profit. In fact, from the bottom of the pattern to the spot where the stock rolls over is a move of 100 percent, or a double-your-money move from below 20 to just about 40. All that in about four weeks! You can see how combining candlestick patterns with RSI signals can tip you off to the best spots to enter a long position.

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