In this latest example, we are going to look at a chart of AIG. In just a few months the stock basically dropped from 400 to below 10. Then out of nowhere the stock just started to move higher… thanks in large part to earnings… which were still pathetic… but that is another story.

I was never really tracking AIG; however, a friend of mine informed me about the massive jump in price. This was when the stock was at $15, which now seems like a steal at this point; nonetheless, I just ignored it assuming the stock will come back down.

Remember that trading is almost 100% perception. Ultimately, analyzing the fundamentals of a company involves trading with emotion. You tell yourself there is no way this stock can move higher. The beauty of technical analysis is that you simple play what the charts tell you, and block out the emotions.

Had I not made the mistake of putting more emphasis on fundamentals and actually put more focus on technical analysis, I might have been enjoying a 100% return in just a couple weeks.

Example of technical analysis at its finest…

By looking at the chart above, you can clearly see the technical indicators that should have made you believe in this upswing.

1. The stock first started a mini wedge pattern into its consolidation phase. The breakout was met with extremely large volume.

2. The second move that should have helped us believe in this stock was the push above the 50 day simple moving average (SMA). Again, there was larger than normal volume.

3. This move was than followed by a bump on the 200 SMA, and a retreat towards the 50 SMA. Good spot for entry had you not been in yet.

4. Then, with significant volume, this stock breaks passed the 200 SMA.

5. Finally, all this move was in coordiation with extremely nice volume and the relative strength index (RSI) breaking over 50.

So you can clearly see that there were 5 absolutely clear reasons that should have easily had us making money on this upswing in AIG.

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There is mathematical equation, but most people will utilize RSI within the tools of a chart. The only customized option for RSI is the period length you want to examine. Obviously long-term traders will prefer extended periods such as 30, while many swing traders will find 14 more significant. It is up to the trader to play around and determining which is best for them.

If you are familiar with stochastic, then understanding RSI won’t be too difficult. The main difference is the cycle number of 30 to 70.

Relative Strength Index Uses

Overbought/Oversold

In general RSI ranges between 30 and 70. Below 30 classifies oversold and above 70 distinguishes overbought. Many traders look at RSI falling below 70 as a bearish signal and breaking above 30 as a bullish indicator.

Centerline

The middle of the range stands at 50, and can also be used as various confirmations of different price movements. Consider RSI coming from 70 and bouncing off 50 to head higher. That is looked at as a bullish indicator. Obviously, the opposite of coming from 30 and bouncing down off 50 is looked at as bearish. Traders also look at a crossover of the line as final confirmation that the stock’s current momentum is ready to change.

Example

As you can see from the chart above, RSI does a good job of predicting change in momentum. Within this example, the 50 line acted as a pretty substantial barrier. Until Intel was able to move past it, the stock could never really head higher.

Where the stock stands now, if the RSI was to head below 50, then that would be a bearish indicator.