Relative Strength Index (RSI) & How I Use It

orionstafa
May 30, 2022
8 min read

What Is the Relative Strength Index (RSI) and How Does It Work?

The relative strength index (RSI) is a technical analysis indicator that examines the size of recent price fluctuations to determine if a stock or other asset is overbought or oversold. The RSI is represented by an oscillator (a line graph that travels between two extremes) with a range of 0 to 100. J. Welles Wilder Jr. created the indicator and published it in his important 1978 book "New Concepts in Technical Trading Systems." 1

Values of 70 or higher on the RSI, according to traditional interpretation and usage, signal that an investment is becoming overbought or overvalued, and may be ready for a trend reversal or corrective retreat in price. A reading of 30 or less on the RSI suggests that the market is oversold or undervalued.

The Formula for the RSI

The RSI is calculated using a two-step process that begins with the following formula:

RSI step one=100 − <1+ Average gain100 Average loss>

................................................................... <Average loss>

The average gain or loss used in the calculation is the average percentage gain or loss during a look-back period. The formula uses a positive value for the average loss. Periods with price losses are counted as 0 in the calculations of average gain, and periods when the price increases are counted as 0 for the calculation of average losses.

The standard is to use 14 periods to calculate the initial RSI value. For example, imagine the market closed higher seven out of the past 14 days with an average gain of 1%. The remaining seven days all closed lower with an average loss of −0.8%.

The calculation for the first part of the RSI would look like the following expanded calculation:

55.55=100−⎣⎢⎡1+(140.8%)(141%)100⎦⎥⎤

Once there are 14 periods of data available, the second part of the RSI formula can be calculated. The second step of the calculation smooths the results.

RSI step two=100−[1+((Previous Average Loss×13)+Current Loss)(Previous Average Gain×13)+Current Gain100]

Calculation of the RSI

The RSI can be calculated using the calculations above, and the RSI line can then be placed beneath an asset's price chart.

The RSI rises as the frequency and magnitude of positive closes rises, and falls as the number and size of losses rises. In a rapidly trending market, the second half of the formula smooths the outcome, thus the RSI will only be near 100 or 0.

While the company is on an uptrend, the RSI indicator can stay in the overbought region for extended periods of time, as shown in the chart above. When the stock is in a decline, the indicator may potentially stay in oversold area for a lengthy time. For inexperienced analysts, this can be perplexing, but learning to apply the signal in the context of the current trend helps clear things up.

What Does the RSI Tell You?

The stock or asset's primary trend is a useful tool for ensuring that the indicator's readings are correctly comprehended. For example, well-known market expert Constance Brown, CMT, has propagated the theory that an oversold RSI reading in an uptrend is likely much higher than 30%, and an overbought RSI reading in a downtrend is likely much lower than 70%. 2

As shown in the chart below, during a downtrend, the RSI will peak near 50 percent rather than 70 percent, which can be utilized by investors to more consistently signal bearish conditions. When a strong trend is in place, many investors will draw a horizontal trendline between 30% and 70% to help them detect extremes. When the price of a stock or asset is in a long-term horizontal channel, changing overbought or oversold levels is usually unnecessary.

Focusing on trade signals and strategies that conform to the trend is a related idea to employing overbought or oversold levels relevant to the trend. To put it another way, employing bullish signals when the price is in a bullish trend and bearish signals when the stock is in a bearish trend will assist you avoid the RSI's many false alarms.

Interpretation of RSI and RSI Ranges

When the RSI exceeds the horizontal 30 reference level, it is considered bullish, and when it falls below the horizontal 70 reference level, it is considered bearish. To put it another way, RSI values of 70 or higher signal that an investment is becoming overbought or overvalued and is likely to see a trend reversal or corrective price decline. A reading of 30 or less on the RSI suggests that the market is oversold or undervalued.

RSI values may fall into a band or range during trends. During an uptrend, the RSI should be over 30 and close to 70 on a regular basis. The RSI rarely exceeds 70 during a downtrend, while the indicator typically falls to 30 or lower. These rules can help you gauge the strength of a trend and identify potential reversals. If the RSI cannot reach 70 on several successive price swings during an upswing but then falls below 30, the trend has weakened and may be reverting lower.

In a decline, the converse is true. If a downtrend fails to reach 30 or lower and then rises over 70, it has weakened and may be turning to the upside. When using the RSI in this fashion, trend lines and moving averages are useful tools to incorporate.

Example of RSI Divergences

When the RSI delivers an oversold reading, followed by a higher low that corresponds to similarly lower lows in the market, this is known as a positive divergence. This suggests that bullish momentum is building, and a breach above oversold area could signal the start of a new long position.

When the RSI delivers an overbought reading followed by a lower high that matches the price's higher highs, this is known as a bearish divergence.

A bullish divergence was found when the RSI created higher lows while the price formed lower lows, as shown in the chart below. Although this was a valid indication, divergences are uncommon when a stock is in a long-term trend. More potential signs can be identified by using flexible oversold or overbought readings.

Image

Example of RSI Swing Rejections

Another trading strategy looks at how the RSI behaves when it resurfaces from overbought or oversold zone. This signal is known as a bullish "swing rejection," and it consists of four components:

The RSI falls into oversold territory.
The RSI crosses back above 30%.
The RSI forms another dip without crossing back into oversold territory.
The RSI then breaks its most recent high.

The RSI indicator was oversold, broke up through 30%, and established the rejection low that triggered the signal when it bounced higher, as shown in the chart below. Drawing trend lines on a price chart is quite similar to using the RSI in this way.

The bearish version of the swing rejection signal, like divergences, is a mirror image of the bullish version. There are four aspects to a bearish swing rejection:

The RSI rises into overbought territory.
The RSI crosses back below 70%.
The RSI forms another high without crossing back into overbought territory.
The RSI then breaks its most recent low.

The bearish swing rejection signal is depicted in the chart below. This signal, like most trading approaches, will be most reliable when it follows the long-term trend. During downtrends, bearish signals are less prone to cause false alarms.

What Is the Difference Between the RSI and the MACD?

Another trend-following momentum indicator is the moving average convergence divergence (MACD), which depicts the connection between two moving averages of a security's price. By subtracting the 26-period exponential moving average (EMA) from the 12-period EMA, the MACD is calculated. The MACD line is the result of the calculation.

The "signal line," a nine-day EMA of the MACD, is then plotted on top of the MACD line, which can be used as a trigger for buy and sell signals. When the MACD crosses above the signal line, traders can purchase the security, and when the MACD crosses below the signal line, they can sell it, or short it.

The RSI was created to show if an investment is overbought or oversold based on recent price levels. The RSI is calculated by averaging price gains and losses over a specified time period. With values ranging from 0 to 100, the default time period is 14 periods.

The MACD evaluates the relationship between two exponential moving averages (EMAs), whereas the RSI monitors price movement in relation to recent highs and lows. These two indicators are frequently combined to give analysts a more comprehensive technical view of a market.

Both of these indicators are used to determine an asset's momentum. However, because they measure various things, they might sometimes yield contradicting results. For example, if the RSI remains above 70 for an extended period of time, it indicates that the security is overextended on the purchase side.

At the same time, the MACD may imply that the security's buying momentum is still increasing. By displaying divergence from price, any indicator may indicate an impending trend change (the price continues higher while the indicator turns lower, or vice versa).

Limitations of the RSI

The RSI compares bullish and bearish price momentum and displays the results in an oscillator that can be placed beneath a price chart. Like most technical indicators, its signals are most reliable when they conform to the long-term trend.

True reversal signals are uncommon, and distinguishing them from false alarms can be difficult. A bullish crossover followed by a sharp decrease in a stock, for example, would be a false positive. When there is a bearish crossover, but the stock quickly accelerates upward, this is referred to as a false negative.

When an item has substantial momentum in either direction, the indicator might stay overbought or oversold for a long time since it represents momentum. In an oscillating market, where the asset price alternates between bullish and bearish moves, the RSI is most beneficial.

What Does the Relative Strength Index (RSI) Measure?

Traders use the Relative Strength Index (RSI) to determine the price momentum of a stock or other instrument. The RSI's primary concept is to track how quickly traders are bidding up or down on a security's price. On a scale of 0 to 100, the RSI plots this outcome. Stocks with ratings below 30 are considered oversold, while those with readings above 70 are considered overbought. Traders will frequently post this RSI chart alongside the security's price chart so that they can compare the security's recent momentum to its market price.

What Is an RSI Buy Signal?

If a security's RSI value falls below 30, some traders consider it a "buy signal," implying that the security has been oversold and is due for a rebound. However, the signal's dependability will be influenced by the whole context. If the security is in a major decline, it may continue to trade at an oversold level for a long time. Traders in that situation may decide to hold off on buying until they get additional confirmation indications.

What Is the Difference Between the RSI and Moving Average Convergence Divergence (MACD)?

Both the RSI and the moving average convergence divergence (MACD) are indicators that aim to assist traders comprehend a security's recent trading behavior, but in different ways. In essence, the MACD smooths out the security's recent price movements before comparing that medium-term trend line to another trend line that shows the security's more recent price changes. Traders can then decide whether to buy or sell when the short-term trend line comes above or below the medium-term trend line.

Tips:

I like to short using the RSI when the Mark is on a down trend or Bear market, but the RSI is overbought above 70 possibly even higher would be even better like #AAPL is now if you look at $AAPLs hourly RSI right now is at 81.8. and if the stock is running into a resistance that makes your odds that much better. Let's See were on a down trend, Overbought RSI on the Hourly, and #AAPL has a $150 level of resistance for a day trader those are some pretty good odds to go short #AAPL