Observing Head and Shoulders in the RSI

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By Fan Yang | April 20, 2011 1:12 AM EST

Analysts and traders often look for chart patterns in price action. Price action is real-time representation of market action therefore provides primary clues. All technical indicators are derived from price data (open, close, high, low, range of hi-lo etc.) Therefore, by construction, all technical indicators are lagging. But that doesn't mean all the signals provided by technical indicators are lagging.

The RSI is an oscillator that reflects the momentum of the market. Readings above 70 represent overbought conditions, while readings below 30 represent oversold conditions. There are many interpretations of the RSI reading, and one of them is chart patterns. We know that head and shoulder in price action suggests a reversal. What about those found in the RSI near the overbought level, or inverted ones found near oversold readings?

Here are some completed Head and Shoulders in the RSI...

AUD/JPY 4H Chart

More of a rounded top than a head and shoulder, but the same dynamic was presented in the RSI. Price action saw a head and shoulder as well after it was observed in the RSI first.

EUR/USD 4H Chart

The head and shoulder spotted in the RSI preceded the topping action, that can arguably also be a head and shoulder.

NZD/USD Weekly Chart. The H&S did not follow through.

Here we have a head and shoulder with the shoulders much lower than the previous two. Nonetheless it did break the neckline. However, a pullback in the RSI broke back into the pattern, and even pushed above the previous "shoulder" level. Price action continued a bullish trend.

Here are some still in development...

AUD/USD Daily Chart

Will the RSI in the AUD/USD complete a head and shoulder? Will price action follow with a double top?

There is a bearish divergence. The second high of the RSI is also a head and shoulder, and already showing signs of completion, with a minor pullback that appears to be signaling that silver might see some topping here.

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