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How does this price and RSI pattern respond to a gradual price decline? Figure 4 shows the divergence pattern between the price trend of July 1983 lumber and RSI during the period of March 10 through April 5. Closing prices during this period are flat, while the RSI trend is rising. RSI displays its tattletale spike on March 23 as prices rise inside their downward channel. Prices then crawl their way down in a truly gradual decline. Between March 25 and April 5, the RSI looks as if it might be signaling a trade three separate times.

Assume you were a buyer on the close of March 25 at $198.00. You would have had an unrealized loss of 24 ticks up to the time when support was actually reached, not a serious loss in the lumber market. Your stop-loss order should have been placed below the support level, effectively keeping you in the trade. The near-term low price of $195.60 on March 11 was tested again on April 6 and held. Prices then recovered to close that day at $196.90, which was a modest 11 ticks below your entry level. Even a nervous trader would have been able to survive the seven days between March 25 and April 5 until prices reached the support zone.

In the price consolidation of April 19 through 27, the RSI pattern displays a spike on April 25 and then a short slide into rising support. This pattern should look familiar. At this point, you may have been somewhat unwilling to move quickly after having suffered through the last long-awaited trading signal, but hindsight proves that adding to your established position at this point was the correct thing to do. Figure 5, a chart of July 1986 lumber, is an example of a pattern not realized. Here, the RSI does not exhibit rising support, which was an important factor in the previous examples. From January 13 through February 5, both prices and the RSI make new lows . The trend reverses and prices rise on completion of the failure indicated by the price spike on February 34. The shallow downside day on February 5 should have alerted you to the developing reversal.

To better understand this trading signal, let's go back to an earlier point on the chart, August 23, 1985. The closing price of February 5 is clearly lower than that of August 23. Examining the RSI on August 23 and February 5 reveals that it established a support zone at just about the 28 level on both occasions. It is not wise to get involved in price events that play out over this long a period, but when the RSI regularly finds support at a given level and no new fundamentals seem to affect the market, then those RSI levels become relevant. Look for price to find support as the RSI settles into its own support level. Gauging the validity of the trading signal then becomes a matter of deciding whether the RSI-price pattern has concluded. After a price consolidation of February 23-24, an aggressive resumption of the upward price trend follows.