RSI Indicator

 Relative Strength Index (RSI) Indicator

The relative strength index (RSI) indicator is one of the most popular technical indicators and it is adjusted by the amount by which the market increased or fell. The RSI values range from zero to 100 and a high RSI occurs when the market has been increasing rapidly. A low RSI occurs when the market has been selling off sharply on lower timeframes.

What is the Relative Strength Index (RSI)  Indicator?

The relative strength index (RSI) indicator is an oscillating indicator that is designed to measure a stock's momentum, which is both the speed and size of price changes. This indicator is frequently used by investors to determine if a stock is overbought or oversold. 

This data may be used to identify probable entry and exit trading signals. The RSI indicator exhibits significant levels of volatility, frequently hitting extreme highs and lows and producing indications that are in conflict in flat markets.

How is RSI calculated?

The RSI is calculated by

First identify a previous period to use, the period is generally 14 days, but can be shorter or longer. After that, total the average gains and divide them by the average losses for the selected timeframe. The relative strength of computation is its result or value. On a graph between 0 and 100, the relative strength value is then plotted.

                             RS= Average Gains

                                    Average Losses

 

Plotting a line help investors measure momentum in relative terms, which means looking at the indicator's current value about past values. This comparison might make it simpler to spot the potential reversal of a stock's trend.

How investors use this RSI indicator to identify potential trading signals.

You can use the RSI indicator as an overbought and oversold indicator to help identify potential trend changes, The RSI is indeed useful for gaining an overview of the overbought and oversold conditions of the market. But it shouldn't be used as a trading signal without confirmation.  

Overbought refers to a stock that is increased rapidly in a short period (above 70) and may reverse lower. Conversely, oversold refers to a stock that has decreased sharply in a short period (below 30) and may reverse higher.

An important tip to increase your chances of trading overbought and oversold areas is to combine support and resistance levels with the RSI and look for areas of confluence between the RSI and strong areas of support and resistance on a chart on overbought.

Because RSI at the 70 level means nothing but RSI at the 70 levels and the price at an important level of resistance has a higher probability for a successful short, and RSI at the 30 level means nothing but RSI at the 30 levels and the price at an important level of support has a higher probability for a successful long.

How the RSI indicator can be used to spot potential trend reversals.

The RSI indicator may indicate a trend reversal when it displays a divergence. There is a divergence when the price of stock swings one way while the RSI moves in the opposite direction.

Examples of RSI Divergence

• A bullish divergence occurs when the RSI indicator makes higher lows while a stock makes lower lows. This may indicate the conclusion of the downward momentum and the possibility of a positive reversal. An investor can utilize a cross back above the 30 levels as an entry signal after seeing a bullish divergence.

• A bearish divergence occurs when a stock's highs are higher but the highs on the RSI indicator are lower. This may indicate that the upward momentum is waning and that a bearish reversal may be imminent. An investor may utilize a cross back below the 70 levels as an exit signal after noticing a bearish divergence.

Another way to trade with the RSI indicator is to take signals around the 50 levels. A buy signal is produced when the RSI crosses above 50. And a sell signal is generated when the RSI crosses below 50. 

This leads some people to think when RSI crosses the 50 levels to the upside that a trend is up. And when the RSI drops below the 50 levels that the trend is down because during trending market conditions, they're a sign indicator and will offer very good signals.

 

Advantages and Disadvantages of the RSI indicator

• The RSI indicator is very good during trending market conditions combined with moving averages and also is excellent at identifying divergences on a chart and overbought and oversold areas at the same time.
• Using the RSI indicator to spot divergences and identify potentially oversold and overbought conditions can help investors find potential trading signals. However, this doesn't mean using RSI is foolproof.
• The RSI signals aren't always accurate, because RSI can't factor in events that influence a stock's price, such as economic news, earnings, and other fundamental aspects.
• RSI  indicator can also stay overbought or oversold for extended periods. So even if a divergence suggests that the stock might move in a certain direction, there is no guarantee.
• The RSI indicator is a lagging indicator that lacks some of the information required to analyze price activity effectively. For this reason, RSI is usually used in conjunction with other forms of confirmation, such as volume and the overall trend in the broader market.