Magic with RSI and Fabonacci Levels


Oct 04 - 10, 2004





Reminiscent to the ongoing battle of bulls and bears there is always this continuous debate whether our stock markets are more affected by the fundamentals or they behave according to the technical analysis based on historical data. Without attempting to settle this argument; here we will explain and demonstrate with real life examples, a few interesting technical indicators which captivatingly enough, do manage to forecast the market behavior to a great extent with reliable accuracy; especially the points of transitory but immediate reversals. Additionally, the precise Entry and Exit points can also be established.


RSI (Relative Strength Indicator) is one of those few indicators that can be categorized as extremely effective in any market even the particularly speculative ones such as our own local stock exchanges. Introduced by J. Welles Wilder, who himself repeatedly admitted that RSI was one of the most interesting concepts he ever worked with, more technical details are described in his monumental book "New Concepts in Technical trading". RSI fundamentally indicates oversold (when it reads 30 or below) or overbought (70 or higher) conditions for a security based on the relatively recent historic data. In essence these points represent the whirling point of a trend. It should be noted, however, that RSI alone must not be trusted to determine the oversold/overbought market conditions. It is strongly recommended that at least one of the similar indicators (which we would be discussing in the later articles) must compliment the reading of market highs or bottoms.

We shall see the real life action of RSI later in this article after the explanation of Fabonacci.


A free falling ball after hitting the ground rebounds back at almost 2/3rd of the distance; this is the shortest possible explanation of Fabonacci levels. As a common occurrence it is observed that after a long rally in either direction the market tends to pull back towards the reverse direction at least momentarily anyway, and most often than not the measurement of this pullback is the 2/3rd of the original move. Thus three most popular levels are 30.8%, 50%, and the most effective is 60.8%, it is fascinating really that a mathematical sequence should predict the human trading behaviors with such astounding accuracy but it does over and over again, even in the intraday trade the Fabonacci patterns can be observed.


The example I am about to quote is a few weeks older graph of SNGP (Sui Northern Gas). The scale on the left indicates the RSI while the scale on the right reads the price of the security; likewise the black line below is the RSI level. The blue grid is the fabonacci retracement level while the Green and Red Arrows indicate Buy and Sell positions respectively.

By Mid July 2004 SNGP was heading in a bearish pattern without correction, From an Investor's stand point, however, the decision to Exit the wining short positions was enormously difficult, it was then suggested that those stocks should be held until the RSI shows an extreme oversold reading (30), it wasn't until the 8th of August when the RSI was 30 and then price made a Low of 59.20. The client was advised to immediately reverse the position to Long Exiting the Short positions with a substantial advantage. As expected the market honored the RSI' prediction and the trend was soon inverted to bullish and within the same day it reached a high price of 61.20 and closed at 61.00; hence the recent position was again a winning one.

Conversely to ascertain the Exit point in the current scenario was quite complicated. Having to deal with a rally which is essentially a correction against a bearish pattern becomes tricky at times. Curiously enough these corrections when they do occur regardless of the general market trend head their own path i.e. can possibly be in the exact opposite direction of market. This is where the Fabonacci levels come in to play as they aid in deducting the exact "Cut and Reverse" points for such corrections. The most likely in most cases (after being verified historically off course) is the 61.8% level. A careful study of the graph will reveal that SNGP almost retraced 61.8% back before (in reality it actually exceeded that level with a point or two and reached a High of 64.50) continuing its downtrend; it was at that stage when this Long position was exited with a significant advantage and a short position was again initiated to take further and more considerable benefit of the decline.

In a way RSI and Fabonacci levels are interrelated to each other as one tends to envisage the temporary reversal of a trend and the beginning of a correction while the other estimates the extent of a rebound. Even while trading at extremely volatile markets such as KSE, after some practice and careful analysis both can be used to maximum effect.



Disclaimer: The author and the magazine hereby state that this article by any means is not a recommendation to buy or sell, but rather a guideline to interpreting the indicators and chart patterns. This information should only be used by investors who are aware of the risk inherent in securities trading. Investors should understand that any security investment involves a degree of risk.

Refrences: "New Concepts in Technical trading". By J. Welles Wilder
Expert Review: Mr. Junaid Zakaria (Equities Manager) Prime Securities.
Relevant Data and Charts provided by: Ms. Masooma Naz, Prime Securities.