Thanks for the quick replies guys. As I'm reading responses, I'm finding that my concerns are not just about the insulation,but also the vapor barrier.
I've read on some of the threads here that some people argue that a plastic vapor barrier over insulation will trap moisture between the exterior tar paper on the house, and this new layer, so that should not be done. That's why people say to use the Redgard.
Last night I found the NJ Residential construction code here:
http://ecodes.biz/ecodes_support/free_resources/NewJersey/2009/09NJ_Residential/PDFs/Chapter%206_Wall%20Construction.pdf
and I'm interpreting it as I have options.
Here's what I was planning on doing, please tell me if I'm missing something:
1. (still need to pick an insulation)
2. apply Durock fiberboardon all walls, and also installing a "Ready Niche" above the bathtub.
3. cover all seams with fibritape and then mortar
4. apply Redgard to all durock surfaces
5. caulk the seams between durock and bathtub.
6. thinset, tile, and grout (all rolled into one)
7. Finally coat all tile with a Sealer
Also, please check out this video of the wall (you won't be rick-rolled, I promise):
http://youtu.be/VMWZl7L-B28