Relative Strength Index
The Relative Strength Index (RSI) is a momentum indicator used in technical analysis that measures the magnitude of recent price changes to estimate overbought or oversold conditions in the price of a stock or other asset. The RSI is displayed as an oscillator (a line chart that moves between two extreme points) and can range from 0 to 100. The indicator was originally developed by J. Wells Wilder Jr. and presented in his seminal 1978 book “New Concepts. in technical trading systems “.
RSI is an oscillator which is used for identifying the technical strength or weakness in a particular scrip. It is a technical momentum indicator that compares the magnitude of recent gains to the magnitude of recent losses in an attempt to determine overbought and oversold conditions of a security.
The RSI can be calculated for any number of days depending upon the analyst’s choice and his or her preferred time period of trading. The most commonly used time interval is the 14 day RSI. Yet, some analysts use a 5 day RSI, a 7 day RSI or even a 9 day RSI for quick trading.
A trader using RSI should be aware that large surges and drops in the price of a security will affect the RSI by generating false buy or sell signals. The RSI is best used as a valuable complement to to other stock picking tools.
Unlike the MACD Histogram, this indicator has been defining boundaries. It is designed to follow the price momentum as an oscillator that ranges between 0 and 100.
RSI provides four types of trading signals.
- Charting Patterns
- RSI Levels
- Overbought / Oversold
Divergences :- Divergences are used for interpreting the Relative Strength Index.
Bullish Divergences Allow Buy Signals
These occur when prices fall to a new low but RSI makes a shallower bottom than during its previous decline.
Trading Rule: Buy as soon as the RSI turns up from its second bottom, and place a protective stop below the latest little price low.
Bearish Divergences Allow Sell Signals
These occur when prices rally to a new high but RSI makes a lower top than during its previous rally.
Trading Rule: Sell as soon as the RSI turns down from its second top, and place a protective stop above the latest little price high.
Charting Patterns :-
- When RSI breaks its down trend line, place an order to buy above the price trend line in order to catch an upward breakout.
- When RSI breaks its up trend line, place an order to sell below the price trend line in order to catch a downward breakout.
RSI Levels :-
- Buy when RSI decreases below its lower reference line, then rallies above it.
- Sell or Short when RSI increases above it higher reference line, an then crosses below it.
Overbought / Oversold :- Wilder suggested using 70 and 30 as Overbought and Oversold levels, respectively:
- Generally, if the RSI rises above 30 after falling below 25, it is considered bullish for the underlying security.
- On the Other hand, if the RSI falls below 70 after reaching extreme reading of 80-90, it is considered bearish signal.