What is the True Strength Index (TSI)?
The true strength index is a technical momentum oscillator. The indicator may be useful for determining overbought and oversold conditions, indicating potential trend direction changes via centerline or signal line crossovers, and warning of trend weakness through divergence.
- The TSI fluctuates between positive and negative territory. Positive territory means the bulls are more in control of the asset. Negative territory means the bears are more in control.
- When the indicator divergences with price, that may signal the price trend is weakening and may reverse.
- A signal line can be applied to the TSI indicator. When the TSI crosses above the signal line it can be used as a buy signal, and when it crosses below, a sell signal. Such crossovers occur frequently so use with caution.
- Overbought and oversold levels will vary by the asset being traded.
The Formula for the True Strength Index (TSI) is
The formula for calculating the TSI involves three steps.
True Strength Index (TSI)=Double Smoothed Absolute PCDouble Smoothed PC∗100Price Change (PC)=Current Close Price−Prior Close PricePC Smoothed=25 period EMA of PCPC Double Smoothed=13 period EMA of PC SmoothedAbsolute PC=Absolute Value of Current Close Price−Prior Close PriceAbsolute PC Smoothed=25 period EMA of Absolute PCAbsolute PC Double Smoothed=13 period EMA of Absolute PC Smoothedwhere:EMA=Exponential Moving Average
How to Calculate the True Strength Index (TSI)
The main skill required in computing the TSI is the ability to calculate an EMA.
- Record price changes and absolute price changes in order to calculate an EMA for both these values.
- Calculate the price change 25-period EMA and the absolute price change 25-period EMA.
- Smooth both of these EMAs by applying a 13-period EMA to each of them.
- Compute the TSI value by plugging the now double-smoothed price change and double-smoothed absolute price change into the TSI formula.
What Does the True Strength Index (TSI) Tell You?
The indicator is primarily used to identify overbought and oversold conditions in an asset's price, spot divergence, identify trend direction and changes via the centerline, and highlight short-term price momentum with signal line crossovers.
Since the TSI is based on price movements, oversold and overbought levels will vary by the asset being traded. Some stocks may reach +30 and -30 before tending to see price reversals, while another stock may reverse near +20 and -20.
Mark extreme TSI levels, on the asset being traded, to see where overbought and oversold is. Being oversold doesn't necessarily mean it is time to buy, and when an asset is overbought it doesn't necessarily mean it is time to sell. Traders will typically watch for other signals to trigger a trade decision. For example, they may wait for the price or TSI to start dropping before selling in overbought territory. Alternatively, they may wait for a signal line crossover. (For more, see: What are the Best Indicators to Identify Overbought and Oversold Conditions?)
Signal Line Crossovers
The true strength index has a signal line, which is usually a seven- to 12-period EMA of the TSI line. A signal line crossover occurs when the TSI line crosses the signal line. When the TSI crosses above the signal line from below, that may warrant a long position. When the TSI crosses below the signal line from above, that may warrant sellng or short selling.
Signal line crossovers occur frequently, so should be utilized only in conjunction with other signals from the TSI. For example, buy signals may be favored when the TSI is above the centerline (above zero). Or sell signals may be favored when the TSI is in overbought territory.
The centerline crossover is another signal the TSI generates. Price momentum is positive when the indicator is above zero and negative when it is below zero. Some traders use the centerline for a directional bias. For example, a trader may decide only to enter a long position if the indicator is above its centerline. Conversely, the trader would be bearish and only consider short positions if the indicator's value is below zero.
Breakouts and Divergence
Traders can use support and resistance levels created by the true strength index to identify breakouts and price momentum shifts. For instance, if the indicator breaks below a trendline, the price may see continued selling.
Divergence is another tool the TSI provides. If the price of an asset is moving higher, while the TSI is dropping, that is called bearish divergence and could result in a downside price move. If the TSI is rising while the price is falling, that could signal higher prices to come. This is called bullish divergence.
Divergence is a poor timing signal, so it should only be used in conjunction with other signals generated by the TSI or other technical indicators.
The Difference Between the True Strength Index (TSI) and the Moving Average Convergence Divergence (MACD) Indicator
The TSI is smoothing price changes to create a technical oscillator. The moving average convergence divergence (MACD) indicator is measuring the separation between two moving averages. Both indicators are used in similar ways for trading purposes, yet they are not calculated the same and will provide different signals at different times.
The Limitations of Using the True Strength Index (TSI)
Many of the signals provided by the TSI will be false signals. That means the price action will be different than expected following a trade signal. For example, during an uptrend, the TSI may cross below the centerline several times, but then the price proceeds higher even though the TSI indicates momentum has shifted down.
Signal line crossovers also occur so frequently that they may not provide a lot of trading benefit. Such signals need to be heavily filtered based on other elements of the indicator or through other forms of analysis. The TSI will also sometimes change direction without price changing direction, resulting in trade signals that look good on the TSI but continue to lose money based on price.
Divergence also tends to unreliable on the indicator. Divergence can last so long that it provides little insight into when a reversal will actually occur. Also, divergence isn't always present when price reversals actually do occur.
The TSI should only be used in conjunction with other forms of analysis, such as price action analysis and other technical indicators.