True strength index

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The true strength index (TSI) is a technical indicator used in the analysis of financial markets that attempts to show both trend direction and overbought/oversold conditions. It was first published William Blau in 1991.[1][2] The indicator uses moving averages of the underlying momentum of a financial instrument.[3][4] Momentum is considered a leading indicator of price movements, and a moving average characteristically lags behind price. The TSI combines these characteristics to create an indication of price and direction more in sync with market turns than either momentum or moving average.[5] The TSI is provided as part of the standard collection of indicators offered by various trading platforms.

Calculations

The TSI is a "double smoothed" indicator; meaning that a moving average applied to the data (daily momentum in this case) is smoothed again by a second moving average. The calculation for TSI uses exponential moving averages. The formula for the TSI is:

$TSI(c_0,r,s) = 100 \frac{EMA(EMA(m,r),s)}{EMA(EMA(|m|,r),s)}$

where

c0 = today's closing price
m = c0 − c1 = momentum (difference between today's and yesterday's close)
EMA(m,n) = exponential moving average of m over n periods, that is,
$EMA(m_0,n)=\frac{2}{n+1}\left[m_0-EMA(m_1,n)\right]+EMA(m_1,n)$
r = EMA smoothing period for momentum, typically 25
s = EMA smoothing period for smoothed momentum, typically 13

Interpretation

While the TSI output is bound between +100 and −100, most values fall between +25 and −25. Blau suggests interpreting these values as overbought and oversold levels, respectively, at which point a trader may anticipate a market turn. Trend direction is indicated by the slope of the TSI; a rising TSI suggests an up-trend in the market, and a falling TSI suggests a down-trend.[5][6]

References

1. ^ William Blau (Nov 1991). "True Strength Index". (Technical Analysis of) Stocks & Commodities (traders.com) 11 (1): 438–446.
2. ^ William Blau (Jan 1993). "Stochastic Momentum". (Technical Analysis of) Stocks & Commodities (traders.com) 9 (11): 11–18. "The true strength index (TSI) I introduce here is based on momentum as it occurs in nature, with no need to segregate up and down components of the momentum. ... The double-smoothed true strength index gives a choice to the trader; selection of the smaller smoothing time can be made to satisfy individual trading personalities. ... Calculating the true strength index requires an introduction to exponentially smoothed moving averages (EMA)"
3. ^ Blau, William (1995-03-06). Momentum, Direction, and Divergence: Applying the Latest Momentum Indicators for Technical Analysis. Wiley. ISBN 978-0-471-02729-4.
4. ^ Mark Etzkorn (1997). Trading with oscillators: pinpointing market extremes—theory and practice. John Wiley and Sons. pp. 91–93. ISBN 978-0-471-15538-6.
5. ^ a b Hartle, Tom (January 2002). "The True Strength Index" (PDF). Active Trader.
6. ^ Michael C. Thomsett (2009). The options trading body of knowledge: the definitive source for information. FT Press. p. 268. ISBN 978-0-13-714293-4.