Using RSI to Identify Trend Reversals – XOP Example with Short-term Bearish Setup (Free)

RSI is a momentum oscillator that many chartists use to identify overbought and oversold levels. While RSI above 70 is typically considered an overbought condition, it is also a sign of strong upside momentum that can signal the start of an extended advance. Conversely, RSI below 30 is considered an oversold condition, but it is also a sign of strong downside momentum that can signal the start of an extended decline.

The Oil & Gas Exploration & Production ETF (XOP) provides a case in point. On the chart below, notice how RSI surged above 70 in late November and exceeded 70 again in January, February, March, and June.  RSI did not come close to 30 on the pullbacks, which means chartists using 30 to spot short-term oversold conditions within the uptrend did not get any signals.

Conditions changed in mid July as downside momentum increased substantially and RSI dipped below 30. Prior RSI dips did not come close to 30 and this dip shows above-average downside momentum, which could signal a trend change. Short-term, XOP fell sharply and then forged an island reversal (see candlestick chart lower left). There was NO follow though to this reversal attempt and a pennant formed the last few weeks (bar chart). This is a short-term bearish continuation pattern and a break below the pennant line would argue for further downside. A break above the red resistance zone would call for a re-evaluation.

Even though we are still in a bull market, junk bond spreads widened over the last few weeks and small-caps are seriously lagging. Today’s commentary at TrendInvestorPro analyzed the junk bond spreads and some bearish setups in the Russell 2000 ETF, Russell Microcap ETF, Oil & Gas Exploration & Production ETF and Natural Gas ETF.

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