Table of Contents
- Understanding the Relative Strength Index (RSI)
- What Is the Relative Strength Index (RSI)?
- How the RSI Works
- Calculating RSI
- Plotting RSI
- Why Is RSI Important?
- Using RSI With Trends
- What Is a Bullish RSI Number?
- What Is a Bearish RSI Number?
- Interpretation of RSI and RSI Ranges
- Example of RSI Divergences
- Example of Positive-Negative RSI Reversals
- Example of RSI Swing Rejections
- The Difference Between RSI and MACD
- Limitations of the RSI
- What Is a Good RSI Number to Use?
- Should I Buy When RSI Is Low?
- What Happens When RSI Is High?
- What Is the Difference Between RSI and MACD?
- What Is the Difference Between RSI Divergence and RSI Reversal?
- The Bottom Line
Understanding the Relative Strength Index (RSI)
Let me tell you about the RSI—it's a momentum oscillator that's essential in technical analysis for stocks and commodities, helping you spot shifts in momentum and price direction.
What Is the Relative Strength Index (RSI)?
The RSI is a momentum indicator you use in technical analysis. It measures the speed and magnitude of a security's recent price changes to detect if it's overbought or oversold. You'll see it as an oscillator on a scale from 0 to 100.
Traditionally, if the RSI hits 70 or above, that's overbought. Below 30 means oversold. Beyond that, it can signal securities ready for a trend reversal or corrective pullback.
J. Welles Wilder Jr. developed it and introduced it in his 1978 book, 'New Concepts in Technical Trading Systems.' It's one of the most popular indicators, available on most trading platforms from online brokers.
Key Takeaways
- The RSI is a popular momentum oscillator from 1978.
- It gives signals on bullish and bearish price momentum, often plotted below an asset's price graph.
- An asset is overbought above 70 and oversold below 30.
- Crossing below overbought or above oversold can signal buy or sell.
- RSI works best in trading ranges, not trending markets.
How the RSI Works
As a momentum indicator, the RSI compares a security's strength on up days to down days. This relation to price action gives you an idea of future performance. Use it with other indicators for better trading decisions.
Calculating RSI
The RSI calculation has two parts. It starts with this formula: RSI_step_one = 100 - [100 / (1 + (Average gain / Average loss))].
Average gain or loss is the percentage over a look-back period, using positive values for loss. Gains count as zero in loss calc, and vice versa. Standard is 14 periods.
For example, if seven of 14 days closed higher with 1% average gain and seven lower with -0.8% loss, the first RSI is about 55.55.
Once you have 14 periods, the second step smooths it: RSI_step_two = 100 - [100 / (1 + ((Previous Average Gain × 13) + Current Gain) / ((Previous Average Loss × 13) + Current Loss))]. This keeps RSI near 100 or 0 only in strong trends.
Plotting RSI
After calculation, plot the RSI below the asset's price chart. It rises with more or larger up days and falls with down days.
In charts, RSI can stay overbought in uptrends or oversold in downtrends for long periods. Understand this in the trend context to avoid confusion.
Why Is RSI Important?
You can use RSI to predict security price behavior, validate trends and reversals, spot overbought or oversold levels, get buy/sell signals, and support strategies with other indicators.
Using RSI With Trends
Know the primary trend to interpret RSI right. In uptrends, oversold might be higher than 30; in downtrends, overbought lower than 70.
In downtrends, RSI might peak at 50, signaling bearish conditions. Use horizontal lines between 30-70 in strong trends to identify extremes.
RSI is less reliable in trending markets than ranges. Focus on signals that match the trend to avoid false alarms.
What Is a Bullish RSI Number?
Bullish signals vary by market. Crossing below 30 (oversold) can be bullish in uptrends, but risky in downtrends.
After an uptrend pullback, reversal from 40-50 support signals continued gains.
What Is a Bearish RSI Number?
Crossing above 70 (overbought) and back below can signal bearish in downtrends.
In downtrends, reversal from 50-60 after pullback signals further declines.
Interpretation of RSI and RSI Ranges
In uptrends, RSI stays above 30 and hits 70 often; in downtrends, below 70 and hits 30. This helps gauge trend strength and reversals.
If RSI can't hit 70 in uptrend then drops below 30, trend may break. Opposite for downtrends. Use trendlines and moving averages with it.
Don't confuse RSI with relative strength—the former is single-security momentum, the latter compares multiples.
Example of RSI Divergences
Divergence happens when RSI and price differ, signaling momentum shift. Bullish: price lower low, RSI higher low—buy signal.
Bearish: price higher high, RSI lower high—sell signal. Flexible levels help in trends.
Example of Positive-Negative RSI Reversals
Positive reversal: RSI lower low with price higher low—bullish buy.
Negative: RSI higher high with price lower high—bearish sell.
Example of RSI Swing Rejections
Bullish swing rejection: RSI oversold, crosses 30, dips without oversold, breaks recent high.
Bearish: opposite, from overbought. Reliable when matching long-term trend.
The Difference Between RSI and MACD
MACD shows relationship between two EMAs by subtracting 26-period from 12-period, with a signal line for triggers.
RSI uses gains/losses to measure overbought/oversold. They complement each other but can contradict, like RSI overbought while MACD shows increasing momentum.
Limitations of the RSI
RSI signals are best in long-term trends but rare true reversals; false positives/negatives occur. It stays extreme in strong momentum, so use in oscillating markets.
What Is a Good RSI Number to Use?
For periods, 14 is standard for balance; shorter for day trading, longer for trends. Levels: below 30 buy, above 70 sell, 50 neutral.
Should I Buy When RSI Is Low?
Below 30 might signal buy if oversold, but confirm in downtrends to avoid prolonged lows.
What Happens When RSI Is High?
High RSI means overbought, potential price drop—signal to sell.
What Is the Difference Between RSI and MACD?
MACD smooths price for trendlines; RSI measures momentum from highs/lows.
What Is the Difference Between RSI Divergence and RSI Reversal?
Divergence: indicator lags price; reversal: price lags indicator. Both can be bullish/bearish.
The Bottom Line
Overall, the RSI is a top momentum oscillator for measuring price speed and changes, giving insights on overbought/oversold, reversals, and trends on a 0-100 scale.
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