The true strength index (TSI) is often overshadowed by moving average convergence divergence (MACD) and relative strength index (RSI). But the truth tells that TSI can be incredibly reliable to determine the trend strength and direction. It is beneficial for traders to initiate new positions or determine when an existing trend is about to end to close positions. Overall, the TSI indicator can be used on all time frame charts and is especially useful in crypto because the trends can last a long time.
This guide will walk you through step-by-step to apply the TSI indicator and how to interpret the trade signals based on the overbought and oversold levels and crossovers.
What is the True Strength Index?
The true strength index (TSI) is a momentum oscillator used in technical analysis to determine the strength and momentum of a market’s trend. TSI helps determine if a market is changing trends and if a market is overbought or oversold.
When interpreted correctly, a trader can initiate new positions in the direction of the new trend or exit an old trend while hanging on to profits.
Without the true strength index, crypto traders may hold on to stale trends too long, which could lead to unnecessary drawdowns — or missing out entirely on a new trend.
Interpreting the True Strength Index Indicator
There are several different ways to interpret the meaning of the true strength index indicator. In technical analysis, traders can use it to help determine the direction of the market’s trend. Additionally, the TSI indicator can be used to gauge the strength of the trend. Lastly, it can provide signals of an imminent reversal that may develop.
If the signals are interpreted correctly, traders can use the TSI indicator to enter new crypto positions or exit current ones.
The True Strength Index Formula
To better understand how to read the indicator, it’s important to gain a high-level view of how the indicator works. Don’t worry, though — we’ll keep the math minimal. The formula itself is relatively simple:
True Strength Index = 100 × (Double Smoothed PC / Double Smoothed Absolute PC)
The base formula of the TSI calculates the change of price from the current candle relative to the previous candle, also known as price change (PC). If today’s close is greater than yesterday’s, then the change will be a positive number. Conversely, the price change will be negative if today’s close is less than yesterday’s close.
The change of price is recorded for each candle period generating a series of numbers. Then, a 25-period exponential moving average is applied to the number series, creating a new series. Following this, a 13-period exponential moving average is applied, creating another new number series — the double-smoothed price change series.
Lastly, another series is created using the absolute values of the price change, which is run through the same double smoothing process of applying a 25-period EMA, and then another 13-period EMA on top of it. This additional series becomes the double-smoothed absolute price change series.
The formula creates a ratio of the double-smoothed price change to the double-smoothed absolute price change. Therefore, the indicator will be bound between −100 and +100.
The true strength index can be a positive or negative value, and the indicator oscillates around the zero line.
This zero line is also called the centerline, which is important to determine the direction of the trend. As a result, many traders will focus on the true strength index’s centerline to bias their trade direction.
In October 2020, Bitcoin’s TSI crossed above the centerline, suggesting the indicator was turning positive and developing an uptrend. In strong trends, the indicator will remain to one side of the centerline for long periods. Once the indicator breaks below the centerline, it creates a sell signal.
Once the true strength index falls and holds below the centerline, the indicator suggests the market has transitioned to a downtrend. Once in a downtrend, the market is more likely to continue lower so long as the TSI is below zero.
Overbought and Oversold Levels
The true strength index is a bounded indicator with values between −100 and +100. Due to the nature of its calculation, it’s rare for the indicator to reach the high and low portions of this range. However, there are instances where the indicator may reach extremely high levels and is considered overbought or extremely low levels and considered oversold.
For example, if the indicator reaches extremely high levels, then each new candle is experiencing a large positive increase over the previous candle. Therefore, if the TSI begins to move lower, the size of the increases is decreasing.
A trader can use a declining TSI from extremely high readings as a sell signal — or an increasing TSI from extremely low readings as a buy signal.
On the Bitcoin 4-hour chart above, the TSI indicator retreats below −25 to signal the market is in oversold conditions. Once TSI climbs above −25, a trader may interpret that behavior as part of a bullish pattern.
About one week later, the TSI indicator moved above +25 into an overbought condition. As the indicator crosses below +25, a trader is alerted to the loss of momentum to the upside and may react accordingly.
Using the TSI Indicator to Spot Signals
The TSI indicator does a great job of alerting traders to trend direction and strength. TSI can also generate signals, helping traders time entry into and out of positions.
The TSI indicates the size of recent price changes. When the TSI line is growing and getting larger, it suggests the trend is moving higher. Traders can use the TSI line and its positioning on the chart to signal potential turns in the market.
Buy and Sell Signals
One common tool traders apply to indicators is a signal line. The signal line is essentially a moving average of the true strength index.
When a signal line crossover occurs (TSI line crosses the signal line), a signal is created in the direction of the cross.
In the chart above, when the blue TSI line crosses below the red signal line, a bearish sell signal is generated. On the other hand, when the TSI line crosses above the red signal line, a bullish buy signal is created.
Using signal lines has benefits, such as identifying when a trend’s strength and momentum are slowing.
TSI can also generate buy and sell signals based on the crossing of the centerline. A cross below the centerline creates a sell signal, while a cross above the zero line is a buy signal.
Also, a cross below an overbought reading like +25 generates a sell signal. Likewise, a cross above an oversold reading of −25 creates a buy signal.
#Strategy 1: Multi Time Frame Analysis and Centerline Crossovers
One of the most effective tools of the TSI indicator is centerline crossovers. Traders can build a strategy around this strength by conducting multi-timeframe analysis (MTFA).
First, on a daily chart, identify the direction of the trend. Simple price action analysis or using the TSI centerline analysis will help you determine the daily trend’s direction.
Then, scroll down to a smaller time frame chart, such as 2-hour or 4-hour, to wait for buy and sell signals. When the daily trend is up, look for a cross over the centerline as a buy signal. When the daily trend is down, look for the TSI to cross below the centerline for a sell signal. If you get conflicting signals from the daily and intraday charts, then stand aside, as the signal’s validity can’t be confirmed.
On the Bitcoin chart above, TSI stays above the centerline, signaling a bullish trend from October 2020 to April 2021.
When zooming into a 4-hour price chart, we use signal line crossovers of the centerline as indications. As the direction of the daily trend is up from October 2020 to April 2021, we will filter the signals, only seeking buying opportunities. When a sell signal is generated, the long trade is closed, and initiating a short sell trade is ignored.
While the daily trend is up, as we witnessed from October 2020 to April 2021, the trader will only be in a long position. While the daily trend is down, as the chart illustrates after April 2021, the trader will only be in short sell positions, ignoring all long signals.
#Strategy 2: MTFA with Overbought and Oversold Signals
This strategy has some resemblance to the first strategy but allows the trader an opportunity to grab an early entry into the trend. The risk to this strategy is that the trend might not develop, in which case the position is more susceptible to getting stopped out as a losing trade.
First, determine the daily trend direction, just as we’ve illustrated within the first strategy above. The same concept applies when we’re filtering our trade signals in the direction of the daily trend while ignoring entering into trades that run against it.
The trade signal is created when the TSI indicator crosses below the overbought levels of +25 or above the oversold reading of −25.
On the Bitcoin 4-hour chart above, let’s focus on the period from April–June 2021. It’s during this time that Bitcoin sustains a greater than 50% correction of price. The TSI indicator on the daily chart signals a bearish centerline cross on April 21.
From there, a trader would scale down to an intraday chart and look to initiate only short sell positions. Two signals are produced, with the first one in April and the second one in June, keeping the trader positioned for further weakness in Bitcoin.
#Strategy 3: Exit the Position on TSI Trend Lines
A lot of strategies in the marketplace are geared toward finding that “perfect entry.” However, many strategies don’t discuss in too much detail how to find a good exit.
If you feel like your exit strategy could be improved, consider using trend lines on the true strength index to help you.
The above example is an Ethereum 1-hour price chart. If a trader enters the position in late May, going long with a trailing stop loss, they can use the TSI indicator to help them determine when the trend has ended.
In the chart above, draw a trend line connecting common low points of the TSI.
When the TSI indicator breaks the trend line, we have a signal suggesting the previous trend is over, and it’s time to exit the position.
Many charting packages allow traders to set alerts based on certain readings the indicators provide. Setting an alert for when the TSI breaks the trend line is one way to keep informed without having to stare at the chart all day.
Perks of Using True Strength Index and RSI Together
As you can see, the TSI indicator has many benefits as a go-to tool for trading. It does an excellent job of determining the strength of a trend. Therefore, complementing the TSI indicator with the Relative Strength Index (RSI) technical indicator can be a powerful way to confirm divergences between price and momentum.
Going into May 2021, Ethereum is on a monster trend to the upside. Between May 4 and May 12, price divergences are appearing on the TSI. These divergences are confirmed with the RSI as well.
This hints that the risk of a price reversal is high. Over the next several days, Ethereum’s price falls 60%.
Though the true strength index indicator is an effective multi-tool for trading, it does come with limitations.
First, the indicator is calculated using price changes from candle to candle. Thus, the indicator is a derivation of price and may not accurately reflect what the underlying price is doing. Therefore, don’t take the signals at face value. Weigh them within the context of the larger trend.
Additionally, if the TSI is used on shorter time frame charts tend to generate more false signals.
TSI can be effective at gauging trend strength and momentum, but can often generate false trading signals. When utilizing a signal line on the TSI, the propensity for false signals tends to increase.
One way to reduce the number of false signals is by incorporating the indicator on hourly or daily price charts.
TSI is an effective momentum indicator for helping traders determine trend direction, strength, and momentum. It does have its limitations and can be susceptible to false signals. However, if utilized properly, it can help traders identify an asset’s positive and negative territory and the potential turning points where positions can be initiated or closed. In addition, combining TSI and RSI indicators can be a powerful tool for corroborating divergences between price and momentum.