The Relative Strength Index which is commonly abbreviated as RSI is a momentum oscillator which measures the speed and the change of price movements. RSI is a very popular momentum oscillator which was introduced in 1978 and it was developed by J. Welles Wilder. The RSI oscillates in a range between 0 and 100. Usually, the RSI gives us an overbought signal when its value is above 70 and an oversold signal when below 30. Signals can be identified by searching for divergences and failure on swing highs and lows. RSI can be used to identify the general trend.
The RSI is a technical tool which gives traders signals for bullish and bearish price momentum, and it is often plotted beneath the graph of an asset’s price. A stock is usually considered overbought when the RSI is above 70, so it is a selling or a short trade opportunity. Similarly, a stock is usually considered oversold when it is below 30, hence it is a buying or a long trade opportunity.
Calculation for RSI
The RSI has a very simple formula. The basic formula is as follows:
RSI = 100 – [100 / ( 1 + (Average of Upward Price Change / Average of Downward Price Change ) ) ]
Notable highlights for using RSI –
The RSI line or value falling below the overbought line or rising above oversold line is usually seen a signal to buy or sell
RSI gives optimally better results in a stock’s trading ranges/channels
RSI can give false signals during strong trending markets wherein a sell signal might not be the potential swing high or a buy signal may not be a potential swing low
Price behavior at certain levels can be clearly identified for stocks which can also be interpreted as stock operator manipulation zones
Swing trading can be successful by reading RSI values on the weekly chart
Trends reversals can be validated
It can alert you for overbought and oversold stocks for portfolio management using weekly or monthly chart timeframes
Short-term trading can be efficient with buy and sell signals
RSI can be used in synchronization with other indicators for trading strategies or trading systems
RSI Divergences
An RSI divergence is an event when the price moves in the opposite direction of the RSI. The chart may display a change in momentum before a similarity of change of price.
A bullish divergence is an occurrence when the RSI displays an oversold reading which is continued by a higher low which appears with lower lows in the price. This can indicate a rising bullish momentum and a price breakout above this oversold territory could be an opportunity to take a long trade. A bearish divergence is an occurrence when the RSI displays an overbought reading which is followed by a lower high that appears with higher highs on the price.
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