The True Strength Index (TSI) Strategy is a momentum-based trading strategy that uses the True Strength Index (TSI) indicator to identify overbought or oversold conditions in an asset and to generate buy and sell signals. The TSI is a powerful momentum oscillator that helps traders to assess the strength of a trend by smoothing price data and filtering out market noise. By combining the TSI with appropriate risk management techniques, traders can make informed decisions to enter and exit trades with confidence.

The TSI measures momentum by comparing the price change over time while giving more weight to recent price movements. This makes it a responsive and reliable indicator for identifying trends and potential reversals.

What is the True Strength Index (TSI)?

The True Strength Index (TSI) is a momentum oscillator developed by William Blau. It is designed to measure the strength of a price trend by calculating the smoothed difference between two exponentially smoothed moving averages (EMAs) of price changes.

The formula for the TSI is as follows: TSI=EMALong(Price Change)EMAShort(Price Change)TSI = \frac{ \text{EMA}_{\text{Long}}(\text{Price Change})}{ \text{EMA}_{\text{Short}}(\text{Price Change})}

Where:

• Price Change is the difference between the current price and the previous price.
• EMA_{Short} and EMA_{Long} represent the short and long-term exponential moving averages of the price change, respectively.

The TSI oscillates between -100 and +100, with higher values indicating stronger bullish momentum and lower values indicating stronger bearish momentum. Traders typically use the TSI to generate overbought and oversold signals, much like the RSI (Relative Strength Index), while also taking trend strength into account.

Key Components of the TSI Strategy

1. TSI Calculation and Setup

The TSI is calculated using two exponential moving averages (EMAs) of price changes. Typically, a 25-period and a 13-period EMA are used, although traders can adjust the periods based on their preferences or the timeframe being traded.

• TSI above 0: Indicates a bullish momentum.
• TSI below 0: Indicates a bearish momentum.

The TSI value above 25 is typically considered overbought, while a value below -25 is considered oversold.

2. Entry Signals

The True Strength Index (TSI) is used to identify when a market is showing momentum in a particular direction. The key entry signals are based on crossovers of the TSI line with the zero line (the center line), as well as extreme overbought and oversold levels.

• Buy Signal:
  • The TSI line crosses above 0, indicating a shift to bullish momentum.
  • The TSI remains above 0 and starts rising, confirming strength in the upward movement.
• Sell Signal:
  • The TSI line crosses below 0, indicating a shift to bearish momentum.
  • The TSI remains below 0 and starts falling, confirming a bearish trend.

3. Exit Signals

Exiting the position is crucial to locking in profits and limiting losses. The TSI strategy provides exit signals when the momentum weakens or when the price begins to reverse.

• Exit Buy Signal: When the TSI crosses back below 0, indicating that the bullish momentum is losing strength.
• Exit Sell Signal: When the TSI crosses back above 0, indicating that the bearish momentum is weakening and a potential reversal may be imminent.

Additionally, traders can use other technical indicators, such as moving averages or price action, to refine their exit points.

4. Risk Management

Effective risk management is essential to ensure that the TSI strategy remains profitable over time. Here are a few key risk management techniques to implement with this strategy:

• Stop-Loss: Place a stop-loss just beyond recent support or resistance levels or use an ATR-based stop-loss to adapt to changing volatility.
• Take-Profit: Set take-profit levels based on risk-reward ratios (e.g., 2:1) or at key support/resistance levels identified through technical analysis.
• Position Sizing: Adjust the position size based on volatility and risk tolerance. In more volatile markets, reduce the position size to limit exposure.

5. Additional Filters and Confirmation

The TSI strategy works best in markets with clear momentum, but it may produce false signals in sideways or range-bound markets. To increase the accuracy of the signals, traders often combine the TSI with other indicators such as:

• Moving Averages (MA): Use a 50-period EMA to identify the overall trend direction. Only take long signals when the price is above the 50 EMA and short signals when it is below.
• RSI: Use the RSI as a confirmation tool. If the RSI is overbought (above 70) while the TSI gives a buy signal, it may suggest a weakening bullish trend. Conversely, if the RSI is oversold (below 30) while the TSI gives a sell signal, it may indicate a potential trend reversal.

Example of the True Strength Index (TSI) Strategy

Let’s consider a trader applying the True Strength Index (TSI) Strategy to the EUR/USD forex pair:

1. Market Conditions: The trader notices that the EUR/USD is in an uptrend and the 25-period EMA is above the 50-period EMA, indicating a bullish market.
2. TSI Setup: The trader uses a 25-period and 13-period TSI to analyze the momentum of the market. The TSI crosses above 0, confirming bullish momentum.
3. Entry Signal:
   • The TSI crosses above 0 and starts rising, indicating strong bullish momentum.
   • The trader enters a long position based on the confirmation from the TSI.
4. Exit Signal:
   • After a strong upward move, the TSI starts to flatten and then crosses back below 0, signaling a potential reversal of momentum.
   • The trader exits the position, either by setting a take-profit level or by using a stop-loss.
5. Risk Management: The trader sets a stop-loss below recent support levels and a take-profit at a 1:2 risk-reward ratio.

Advantages of the TSI Strategy

• Clear Momentum Indicator: The TSI is a reliable momentum oscillator that helps identify trends with greater clarity, especially in volatile markets.
• Captures Strong Trends: The strategy works well in trending markets and allows traders to capitalize on sustained price movements.
• Adaptable to Multiple Markets: The TSI strategy can be applied to forex, stocks, commodities, and cryptocurrencies, making it a versatile tool for various traders.
• Combines Momentum and Trend: By combining TSI with other trend-following tools like moving averages, the strategy increases the probability of successful trades.

Limitations of the TSI Strategy

• False Signals in Sideways Markets: The strategy performs best in trending markets, and may produce false signals during periods of consolidation or sideways movement.
• Lagging Indicator: The TSI is a lagging indicator, meaning it reacts to price movements and may enter trades after the trend has already begun.
• Requires Confirmation: To avoid false signals, the TSI strategy works best when combined with other indicators, such as RSI or moving averages.

Tools and Technologies

• Trading Platforms: MetaTrader 4/5, NinjaTrader, TradingView for executing and backtesting the TSI Strategy.
• Indicators: TSI, EMA, RSI, MACD for confirmation and additional trend-following.
• Backtesting: Platforms like Backtrader, QuantConnect, or TradingView can be used to backtest and optimize the strategy.

Conclusion

The True Strength Index (TSI) Strategy is a reliable momentum-based trading strategy that helps traders identify the strength of a trend and capture profitable price moves. By using the TSI to measure momentum and combining it with other trend-following tools like moving averages, traders can enter trades with more confidence and manage risk effectively. While it works well in trending markets, it may require additional filters and confirmation to perform optimally in sideways markets.

To learn more about how to implement the TSI Strategy, refine its parameters, and improve your risk management skills, enrol in the expert-led Trading Courses at Traders MBA.