The True Strength Index (TSI) is a momentum-based oscillator, developed by William Blau, designed to determine the trend and overbought-oversold conditions. The TSI is applicable to intraday time frames as well as longer-term horizons.
TSI has 2 lines, 1 of them shows the relative price movement, which tends to be volatile. The second line, called the signal line, signifying relative average movement of price, tends to eliminate volatility and is smoother of the two. As with other momentum oscillators TSI can be used to derive overbought and oversold signals, signal crossovers, center line crossover and bearish and bullish divergences.
To understand TSI mathematically an understanding of the following set of equations is necessary.
Double Smoothed Price Change (PC)
PC = Current Price – Previous Price
1st Smoothing = 25 period EMA of PC
2nd Smoothing (PC) = 13 period EMA of the 25 period EMA of PC
Double Smoothed Absolute Price Change (APC)
Absolute Price Change APC = |Current Price – Previous Price|
First Smoothing: 25-period EMA of APC
Second Smoothing (APC) = 13 period EMA of 25 period EMA of APC
TSI = ( PC/APC ) x 100 ——————————————————-(blue line)
Signal Line = 7-period EMA of the TSI line —————————(red line)
The first part of this trend line is the price change, which if on the rise, will yield a positive result and on the decline will be negative. Narrating the equations, this correlates to the double smoothed price change (PC), this is the 13 period EMA of the 25 period EMA of PC. The second line, is the trend line, is smoother, given that the ratio of Price Change (PC) and the absolute price change (APC), which is PC/APC, tends to be reduced in the TSI equation. In any case a string of positive price changes will result in relatively high positive readings and the converse is also true as the TSI will either attain a high positive value or a deep negative value. Having said this, the center line defines the overall bias with bulls edging when TSI is above it and bears dominating when TSI lies below the center line.
The above chart of Chinese Yuan: US$ shows two different graphs of TSI on a different time range. Notice that the one on the shorter time range TSI (close, 13, 7) is less smoother compared to TSI (close, 40, 20) and also breaches into the oversold and over bought territories more often. The red horizontal line shows the overbought and oversold range. Price breaching into these territories can give an indication that a reversal may be on the onset given the prices have moved into an unsustainable zone. As can be seen on both TSI shows price level breaching into an overbought zone at point “a” when the TSI blue line is above the signal line, which should alert the trader that a reversal may be around the corner. This does occur as the upward price momentum is decreasing, which is shown, by the red trend line remaining below the TSI. The price does decline and at a midpoint between point “a” and “b” an exit point is reached as the TSI momentarily rises over the signal line. After this decline the TSI (13, 7) reaching overbought level at point “b”, it appears that decline may continue as the signal line broadly continues to remain below the TSI during this time zone. . The decline does continue and a day later after reaching oversold point the price moves towards the center Line with negative trade volumes, shown by the inverted histogram, continuing.