Do you know what the Relative Strength Index is? If not, then you are in good company — most people don't. But don't worry, you are about to learn. Keep reading because this article is about to teach you how to trade using the Relative Strength Index or RSI for short.
The Relative Strength Index (RSI) is a momentum oscillator and one of three key technical indicators developed by J. Welles Wilder. The RSI measures the speed and change of price movements. In simple terms, the RSI is a momentum oscillator that measures the speed of stocks' price movements and their changes in direction over a set time period. For example, if you have a stock that keeps going up and down, the RSI will tell you if the recent gains are sustainable based on if those new highs are higher than the previous ones. That is the basic idea of how RSI can be used. It can be used on any time scale and over multiple trading instruments. This is why I believe it to be the most versatile of all indicators.
The Relative Strength Index is a leading indicator that is widely used by technical analysts over the globe. It can be used to catch a general trend. As such, it is not directional and does not predict future price moves; instead, it is used primarily to determine if a market is overbought or oversold. The RSI measures momentum on a scale of 0 to 100. There are two ways to interpret the RSI. First, if the RSI rises above 70, the security is becoming overbought and may be primed for a correction. Second, if the RSI falls below 30, it may indicate that a security is becoming oversold and could soon rally. In short, it is considered overbought when RSI goes above 70 and oversold when it goes below 30. This is the classical approach to RSI.
RSI Calculation
The formula for RSI calculation is as follows –
RSI = 100 – 100 / (1 + RS)
RS = Average Gain over a specified period/ Average loss over the same period
The default setting for the Relative Strength Index is 14 periods, but you may change this value to decrease or increase sensitivity based on your requirement.
For instance, 14-day RSI is more likely to reach overbought or oversold levels quicker than a 30-day RSI.
RSI Uses
RSI is one of the most popular technical indicators in traders' arsenal, used by many to enter and exit trades. Touching on this topic, I will share with you how you can use this indicator to trade securities.
- RSI divergence
- Failure swings
- Midline crossover
- Trendline application
- Pattern breakout and breakdown
- Range shift
RSI Limitations
- RSI is one of the most used indicators in the trading world. Yet it's not a great indicator to use on its own. However, what many traders miss out on is that when rsi is combined with other indicators you can create powerful trade set-ups.
- Like most technical indicators, its signals are most reliable when they conform to the long-term trend.
- Since the indicator displays momentum, it can stay overbought or oversold for a long time when a security has substantial momentum in either direction. Therefore, the RSI is most useful in an oscillating market where the prices are alternating between bullish and bearish movements.
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