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A fingertip touches the screen of a table showcasing a trading chart

 

The Power Swing Indicator (PSI) is a technical analysis tool that can help traders identify potential tops and bottoms of an asset. It works by measuring the momentum behind price swings and looking for divergence between price and momentum. 

When used correctly, PSI can be a powerful indicator for determining when a trend is losing strength and ready to reverse.

In this comprehensive guide, you’ll learn everything you need to know about using the Power Swing Indicator to identify major market turning points. 

 

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Using the Power Swing Indicator

The Power Swing Indicator excels at spotting trend reversals by looking for divergence between price and momentum. 

Divergence occurs when the price makes new highs/lows, but momentum fails to confirm. This alerts us that the current trend is running out of steam and will likely reverse soon.

Here are the main PSI divergence signals you should watch for:

Bearish Divergence (Topping Signal)

  • Price makes higher high
  • PSI makes a lower high

This shows that the upside momentum is waning as buyers lose power. It is time to prepare for a potential reversal to the downside.

Bullish Divergence (Bottoming Signal)

  • Price makes a lower low
  • PSI makes higher low

This shows that the downside momentum is fading as sellers lose interest in an asset - prepare for a potential upward trend reversal.

In addition to divergence, overbought and oversold readings can also flag potential turning points:

Overbought Above +70

PSI rising above +70 signals an extremely overextended uptrend due for a pullback. It is time to lock in long profits or establish short positions.

Oversold Below -70

PSI dropping under -70 indicates a downtrend is exhausted and is ready for a bounce. Look to cover shorts or initiate new longs.

This article may pique your interest: Learning to Decode the Gann Fan Indicator 

 

How to Incorporate PSI into Your Trading Plan

1. Use PSI as a Confirmation Tool

Don’t rely on the Power Swing Indicator alone to trigger trades. Look for the indicator to confirm signals given by your existing strategy. 

Using PSI with price patterns or other technical indicators will improve accuracy.

2. Focus on Clear, Prolonged Divergence

One of the most reliable signals in trading is when the PSI diverges from the price over a prolonged period, indicating that the trend is losing momentum. 

However, it is essential to exercise caution and avoid taking action too soon based on minor, short-term divergences that may not accurately reflect the overall trend.

3. Identify Overbought/Oversold Zones

Mark major PSI peaks above +70 and troughs below -70 on your charts. Then, target reversion trades when the price approaches these extreme momentum readings again. 

This is similar to trading Relative Strength Index (RSI) overbought/oversold levels.

4. Use of Higher Timeframes

The Power Swing Indicator is one of the most reliable indicators regarding signal accuracy. Its effectiveness is most noticeable when applied to longer-term charts, such as daily, weekly, or monthly. 

Yet, it’s important to remember that intraday PSI divergence can sometimes be misleading. Short-term market fluctuations and noise can interfere with the signals’ accuracy.

5. Consider Volume

 

Dark hued bar graphs displaying numerical stock data alongside a laptop positioned on the table

 

If you spot a bearish divergence in PSI, it becomes more credible if the rally is accompanied by lower trading volume. 

Lower trading volume indicates a lack of market participation and interest in the asset. Therefore, a bearish divergence in PSI and lower trading volume can suggest a potential trend reversal.

6. Manage Risk

When trading PSI signals, it is crucial to have a clear strategy in place. One important aspect of this strategy is to use proper stop losses to minimize potential losses in case the anticipated reversal does not materialize. 

Additionally, it is recommended to set reasonable profit targets based on recent price swings or technical levels to maximize gains. Doing so can help you better manage your risk and improve your chances of success in the market.

Combining sensible risk management with PSI’s insights into shifting momentum can help you catch significant tops and bottoms more confidently.

 

Ways to Maximize the Power Swing Indicator

While PSI is a useful leading indicator on its own, there are a few tweaks that can make it even more powerful:

Use Multiple Timeframes

Analyze PSI divergence across longer and shorter timeframes to identify the most vital reversal signals.

The divergence that aligns across charts from monthly to 4 hours increases the likelihood of a sustained trend change.

Smooth the Data

The Power Swing Indicator can sometimes give misleading or early signals due to market noise. 

Applying a moving average smoothing to PSI readings filters out false signals and highlights major momentum shifts. The 20-period SMA is a popular setting.

Note the Speed of Divergence

The faster PSI diverges from price, the more convincing the signal. Gradual divergence develops over months, while rapid divergence can unfold over weeks or days. 

More immediate divergence often leads to more accelerated trend reversals.

Combine With Candle Patterns

 

Vibrant red and green patterns on a stable trading chart indicating a positive upward trend

 

Candlestick patterns are a type of technical analysis tool used to predict future price movements of an asset by analyzing its historical price data. 

Two commonly used patterns are engulfing and doji patterns. When used with PSI divergence, these patterns can confirm the trend’s strength and provide more confidence in the analysis. 

Specifically, a bearish engulfing candle that completes PSI bearish divergence is a sign to traders that it may be an excellent time to consider shorting the asset, as it is a high-probability trading opportunity.

Power Swing Indicator, combined with prudent analysis and risk management, puts the power to identify tops and bottoms squarely in your hands.

You might also like to read: How to Use a Supertrend Indicator for Trading

 

Closing Thoughts

The Power Swing Indicator (PSI) is a powerful momentum oscillator that can provide traders with valuable insights into potential trend reversals and swing points. 

While the PSI can highlight high-probability opportunities, no indicator is perfect. Traders should take the time to learn the nuances of this tool thoroughly, practice trading simulated trades, and refine their skills before risking real capital. 

With dedication to continuous learning and prudent risk management, the Power Swing Indicator can be an invaluable aid for traders looking to catch major tops and bottoms.

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“When considering “CFDs” for trading and price predictions, remember that trading CFDs involves a significant risk and could result in capital loss. Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be considered investment advice.”

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