Hello and welcome to our weekly series of Cantos Charts Masterclass. I'm Sandy Jadeja, Chief Market Strategist for CMS FX. We've taken a look at the Relative Strength Index recently, and I'm going to continue in this lesson by taking a look at how to use this with slightly alternative ways of applying this in the current markets. As always, these are simply for information and education purposes only.

So the RSI has been and is increasingly becoming a popular indicator, especially for day traders, because it's a momentum index. In other words, it can be useful for us for picking up extreme levels in the financial markets.

Now, we'll take a look at some additional ideas, because there are various ways of looking at this. So today, I want to cover different timeframes, but also how we can utilise this 30-to-70 price extreme range.

Now, there are problems with using indicators, and I'm going to go into a little bit more detail as to what sort of problems we may face as technical traders.

The first chart I'm going to look at is the Dow Jones daily. Straightaway, what I've done is to mark off all the highs and then the recent lows that we've seen. The relative strength index is actually at the bottom of the chart. Now, previously we've discussed about using these 30 and 70 zones as an indication of when the market may be at an extreme. Notice, on this particular chart, I'm actually using an 8-period RSI, so I've changed the settings to a really sharper way or for day traders and short-term traders.

Now, the blue lines at the top are marked off at the 70 zone and the blue line at the bottom is marked off at the 30 zone. We can see several times that the Dow Jones had actually hit the upside. But does that tell us that the market is definitely going to bounce off? No. we had a case over here at 10117 where the market came off slightly and then continued higher. The RSI went back into the overbought zone. At 10438 the market actually went sideways to higher. But the indicator headed lower. We didn't reach the lower extreme zone, but we did however flirt with the upper levels at the 70 area.

Now, at 10729, we did get a sharper pullback. We made a low at 10157, followed by 9835. At that point, the indicator had reached the oversold zone. What we notice straightaway is once the market reached 9835, a lower price, there was a divergence setting up on the indicator. So that was probably giving us early warnings that the market may have reached an exhaustion point.

Of course, notice that the Dow Jones has been in an uptrend for several months right now, so it would be ideal to look at the buy zone rather than the sell zone on the upside.

Now, on this chart, what we've done is changed the RSI to a 14 period. So this would be ideal for intermediate-term traders or for slightly longer-term traders. The chart itself hasn't changed, but the RSI has actually not reached the extreme zone at the 70 level on the 14-period RSI. So we get into an argument here. Which one's better to use - the 8 or the 14? It really does depend on your personal timeframe.

If you are a longer-term trader, then of course the 14, which was the original setting set by Welles Wilder, which actually worked quite well back in the '80s, but it's not working as well right now. So we have to adapt these indicators to the current market environment.

We also didn't reach the extreme sell zone. So with the 14 setting, we actually haven't reached any of the buy or sell zones, and the divergences or the breakouts of trend lines would have been much more useful.

In this particular chart, we've actually looked at a 20-period RSI, so again, notice that we haven't reached anywhere near the extreme upper zone or even anywhere near the extreme lower zone. The chart itself has remained the same. So here, I would have preferred to again use a breakout of trend lines or divergences.

Now, in this example, we are looking at Dow Jones daily, but we're looking at the 8-period RSI. Now, what I really want to delve into is the application of these trend lines. Just towards the right-hand side of the chart, the Dow made a high at 10729. Then it came down. We had peaks 1 and 2 on the RSI indicator, and that's where I would have joined my trend lines to those two peaks, and then projected it towards the downside.

A little later on, the RSI broke above the trend line, as an indicated by the blue arrow on the chart, that would have suggested that maybe we have reached an extreme zone and the market should head higher. In fact, if it had stopped just below the previous low, we would have been stopped out. The market made a new low again, and we had a secondary breakout above the trend line, and the secondary breakout has actually served us much better than the first breakout.

So we can find ourselves in situations where we do get false breakouts.

Now, you can use trend lines coming from top to bottom and of course, going from bottom to top as well. So in this example here, again we're using an 8-period RSI. On the indicator itself, notice that we have two peaks just towards the middle of the zone between the 30 and 70, around the 40 area, and then the indicator broke above the green line, and then the market started to rally towards the upside.

So you can get quite creative rather than just using the traditional methods with these indicators, because as the markets adapt, we ourselves as traders need to adapt to the markets.

So the RSI conclusion, really, is it can be useful for identifying extreme levels, but can also fail in many instances. Especially if you're in a bull market, if you start seeing this indicator heading towards the upside, it's not going to provide us with key resistance levels. I'd rather use price for that. But if you're in a bull market and the indicator reaches towards the downside, that's possibly a good area to look for buying positions.

So also experiment with different settings for different markets, because the one size certainly does not fit all in technical analysis. So I think it would be ideal if you start looking at several settings such as the 8, or even the 5 if you're a very short-term day trader. And then moving up towards the 14, 20-period.

But again, start applying these on the daily timeframes as well the weekly and the monthly. And when all of these are in synch, you can possibly find some very good trading opportunities.

In the next session, we'll take a look at how we can combine indicators. So in other words, we'll take a look at how to use two indicators with each other.

In the meantime, have a great trading week. This is Sandy Jadeja for CantosCharts Masterclass.