Relative Strength Index (RSI) Indicator explained
The Relative Strength Index (RSI) Indicator is a momentum oscillator widely used in technical analysis of stocks and commodities to identify changes in momentum and price direction. The relative strength index (RSI) is a momentum indicator used in technical analysis. The RSI measures the speed and magnitude of a security’s recent price changes to detect overbought or oversold conditions in the price of that security. The RSI is displayed as an oscillator (a line chart) on a scale from zero to 100. The indicator was developed by J. Welles Wilder Jr. and introduced in his seminal 1978 book, New Concepts in Technical Trading Systems. In addition to identifying overbought and oversold securities, the RSI can also indicate securities that may be poised for a trend reversal or a corrective pullback in price. It can signal when to buy and sell. Traditionally, an RSI reading of 70 or higher indicates an overbought condition. A reading of 30 or lower indicates an oversold condition. The RSI is one of the most popular technical indicators, and it is widely available on most trading platforms offered by online stock brokers. Of course, it is available in the Viking system as well. – The relative strength index (RSI) is a popular momentum oscillator introduced in 1978. – The RSI provides technical traders with signals of bullish and bearish price momentum, and is often plotted below the graph of an asset’s price. – An asset is usually considered overbought when the RSI is above 70 and oversold when it is below 30. – In some situations, the RSI line crossing below the overbought line or above the oversold line can be seen by traders as a signal to buy or sell. – RSI works best in trading ranges rather than trending markets.
How the Relative Strength Index (RSI) works
As a momentum indicator, the relative strength index compares a security’s strength on days when prices are going up with its strength on days when prices are going down. Relating the result of this comparison to price action can give traders an idea of how a security might perform.2 The RSI, especially when used in combination with other technical indicators, can help traders make better informed trading decisions.3
Calculating the RSI
The RSI uses a two-part calculation starting with the following formula: RSI step one=100-[1001+Genomsnittlig vinstGenomsnittlig förlust]RSI step one=100-
[1+Genomsnittlig förlustGenomsnittlig vinst100]
The average gain or loss used in this calculation is the average percentage gain or loss over a look-back period. The formula uses a positive value for the average loss. Periods of price losses are counted as zero in the calculations of average profit. Periods of price increases are counted as zero in the calculations of average loss. The default number of periods used to calculate the initial RSI value is 14.4 For example, imagine that the market closed higher on seven of the last 14 days with an initial average gain of 1%. The remaining seven days all closed lower with an initial average loss of -0.8%. The first calculation for the RSI would look like the following extended calculation: 55.55=100-[1001+(1%14)(0,8%14)]55.55=100-⎣⎢⎡1+(140.8%)(141%)100⎦⎥⎤ Once there are 14 periods of data available, the second calculation can be made. The purpose is to smooth the results so that the RSI only approaches 100 or zero in a strongly trending market. RSI step two=100-[1001+(Previous Average Gain×13) + Current Gain((Previous Average Loss×13) + Current Loss)]RSI step two=100-[1+((Previous Average Loss×13) + Current Loss )(Previous Average Gain×13) + Current Gain100]
RSI plot
After the RSI has been calculated, the RSI indicator can be plotted, usually below an asset’s price chart, as shown below. The RSI will rise as the number and size of up days increase. It will decrease as the number and size of down days increase. The RSI indicator can stay in the overbought region for extended periods of time while the stock is in an uptrend. The indicator can also remain in oversold territory for long periods of time when the stock is in a downtrend. This can be confusing for new analysts, but learning how to use the indicator within the context of the prevailing trend will clarify these issues.
Why is the RSI important?
– Traders can use the RSI to predict the price behavior of a security. – It can help traders validate trends and trend reversals. – It can point to overbought and oversold securities. – It can give short-term traders buy and sell signals. – It is a technical indicator that can be used with others to support trading strategies.
RSI with trends
Changing RSI levels to suit trends The primary trend of the security is important to know in order to properly understand RSI readings. For example, well-known market technician Constance Brown, CMT, suggested that an oversold reading of the RSI in an uptrend is probably much higher than 30. Likewise, an overbought reading during a downtrend is much lower than 70.5 As you can see in the following chart, during a downtrend, the RSI peaks near 50 rather than 70. This can be seen by traders as more reliably signaling bearish conditions. Many investors create a horizontal trend line between the levels of 30 and 70 when a strong trend is in place to better identify the overall trend and the extremes. On the other hand, it is usually unnecessary to modify overbought or oversold RSI levels when the price of a stock or asset is in a long-term horizontal channel or trading range (rather than a strong upward or downward trend). The relative strength indicator is not as reliable in trending markets as it is in trading ranges. In fact, most traders understand that the signals from the RSI in strong uptrends or downtrends can often be false.
Use buy and sell signals to match trends
A related concept focuses on trading signals and techniques that are consistent with the trend. In other words, using bullish signals primarily when the price is in a bullish trend and bearish signals primarily when a stock is in a bearish trend can help traders avoid the false alarms that RSI can generate in trending markets.
What is a bullish RSI number?
A number of RSI levels can be considered bullish, depending on whether the market is trending up or down or is range-bound. A bullish signal is when the RSI crosses below 30, where it would be considered oversold. However, as mentioned above, bullish RSI signals are best used in uptrends. In a strong downtrend, the trend can continue long after the momentum indicators have reached oversold levels. In addition, any trade entered on this signal may offer limited upside, as you would likely be trading against a strong, recent trend. After a strong uptrend, another bullish RSI signal is a reversal after a decline to around 40-50, an area considered supportive during an uptrend. This is often a confirmation of a positive momentum shift back towards the uptrend after a pullback, signaling potential for continued upsides.
What is a bearish RSI number?
Bearish signals from the RSI look like bullish ones but in reverse. A basic bearish signal is when the RSI crosses above 70, an overbought level. If this is followed by a move below 70, upward momentum can weaken, alerting traders to a potential price reversal.7 But again, bearish RSI signals are best used in downtrends. During a strong downtrend, a bearish RSI signal is a reversal after a rise to around 50-60. This is often a confirmation of a momentum shift back towards the downside after a pullback, signaling potential for continued declines.
Interpretation of RSI and RSI ranges
During trends, the RSI readings can fall within a band or range. During a strong uptrend, the RSI tends to stay well above 30 and should often reach 70. During a strong downtrend, it is rare to see the RSI exceed 70, while it often reaches 30 or lower. These guidelines can help traders determine trend strength and spot potential reversals. For example, if the RSI is unable to reach 70 on a number of consecutive price swings during an uptrend, but then falls below 30, the trend is likely to break down. The opposite is true for a downward trend. If the downward trend cannot reach 30 or below and then rises above 70, that downward trend has been broken and may reverse to the upside. Trend lines and moving averages are useful technical tools to include when using RSI in this way. Be careful not to confuse RSI and relative strength. The first refers to changes in the price momentum of a security. The second compares price movements of two or more securities.
Examples of RSI deviations
An RSI divergence occurs when the indicator and price begin to reach different levels, indicating a change in momentum that precedes a change in price direction. For example, a bullish divergence occurs when the security makes a lower low but the indicator forms a higher low. This indicates a rising bullish momentum and can be used to trigger a new long position. A bearish divergence occurs when price makes a higher high but the RSI makes a lower high. This indicates a possible change to downward momentum. A bullish divergence forms when the RSI forms series of higher lows when price formed lower lows. This was a valid signal, but divergences can be misleading when a stock is in a stable long-term trend. In that case, many divergences can be seen before a reversal occurs. Using flexible oversold or overbought readings will help identify more potential signals.
Example of positive-negative RSI reversal
An additional price-RSI relationship that traders look for are positive and negative RSI reversals. These are the opposite of bearish and bullish divergences. A positive RSI reversal can occur when the RSI reaches a lower low at the same time that a security’s price reaches a higher low. Traders would consider this formation as a bullish sign and a buy signal. Conversely, a negative RSI reversal can happen when the RSI reaches a high that is higher than its previous high while a security’s price reaches a lower high. This formation would be a bearish sign and a sell signal. Example of RSI Swing Rejection Another trading technique examines RSI behavior when it rebounds from overbought or oversold territory. This signal is called swing rejection. A bullish rejection has four parts: 1. RSI falls within the oversold territory. 2. RSI crosses back above 30. 3. RSI forms another dip without going back into oversold territory. 4. RSI then breaks its recent peak. As you can see in the following chart, the RSI indicator was oversold, broke up through 30 and formed rejection lows which triggered the signal when it bounced higher. Using the RSI in this way is very similar to drawing trend lines on a price chart. There is a bearish version of the swing rejection signal which is a mirror image of the bullish version. A bearish swing rejection also has four parts: 1. RSI rises to overbought territory. 2. RSI crosses back below 70. 3. RSI forms another high without reaching overbought territory. 4. RSI then breaks its recent low. As with most trading techniques, this signal will be most reliable when it is consistent with the prevailing long-term trend. Bearish signals during downtrends are less likely to generate false alarms.
The difference between RSI and MACD
The moving average convergence divergence (MACD) is another trend-following momentum indicator that shows the relationship between two moving averages of a security’s price. The MACD is calculated by subtracting the 26-period exponential moving average (EMA) from the 12-period EMA. The result of that calculation is the MACD line. A nine-day EMA of the MACD, called the signal line, is then drawn on top of the MACD line. It can act as a trigger for buy and sell signals.10 Traders can buy securities when the MACD crosses above its signal line and sell, or short, securities when the MACD crosses below the signal line. The RSI was designed to indicate whether a security is overbought or oversold relative to recent price levels. It is calculated using average price gains and losses over a given time period. The standard time period is 14 periods, with values ranging from 0 to 100.11 The MACD measures the relationship between two EMAs, while the RSI measures the rate of price change relative to the peaks and troughs of recent prices. These two indicators are often used together to give analysts a more complete technical picture of a market. Both indicators measure an asset’s momentum. However, they measure different factors and can sometimes give conflicting indications. For example, the RSI may show a reading above 70 over an extended period of time, indicating that a security is overextended on the buy side. At the same time, the MACD may indicate that the buying momentum is still increasing for the security. Both indicators can signal an upcoming trend change by showing divergences from the price (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 placed below a price chart. Like most technical indicators, its signals are most reliable when they are consistent with the long-term trend. True reversal signals are rare and can be difficult to distinguish from false alarms. A false positive, for example, would be a bullish crossover followed by a sudden decline in a stock. A false negative would be a situation where there is a bearish crossover, but the stock suddenly accelerated upwards. Since the indicator shows momentum, it can remain overbought or oversold for a long time when an asset has significant momentum in either direction. Therefore, the RSI is most useful in an oscillating market (a trading range) where the asset price alternates between bullish and bearish movements.
What is a good RSI number to use?
This question may refer to the time frame used in an RSI calculation. Choosing the right RSI period depends on your trading style, timeframe and market conditions. The default is a 14 period timeframe, which provides a balanced response to price changes and is well suited to swing and position trading. Using shorter periods between 5 and 9 makes the RSI more sensitive and appeals to day traders who want to capture rapid momentum shifts, although they tend to generate more noise. Meanwhile, using longer periods, like 21 to 30, suits long-term investors who want to catch big trends. On the other hand, a “good RSI number” can also refer to RSI levels. When the RSI is below 30, it signals that the security may be oversold or undervalued – meaning it could be a good time to buy. When the RSI is above 70, it signals that the security may be overbought or overvalued – meaning it may be a good time to sell. An RSI of 50 signals a neutral balance between bullish and bearish positions.
Should I buy when the RSI is low?
Some traders consider it a buy signal if a security’s RSI reading moves below 30. This is based on the idea that the security has become oversold and is therefore poised for a recovery. However, the reliability of this signal will depend on the overall context. If the security is caught in a significant downtrend, it may continue to trade at an oversold level for quite some time. Traders in that situation may postpone buying until they see other technical indicators confirm their buy signal.
What happens when the RSI is high?
Since the relative strength index is mainly used to determine whether a security is overbought or oversold, a high RSI reading may mean that a security is overbought and the price may fall. Therefore, it can be a signal to sell the security.
What is the difference between RSI and Moving Average Convergence Divergence (MACD)?
RSI and moving average convergence divergence (MACD) are both momentum measurements that can help traders understand a security’s recent trading activity. But they accomplish this goal in different ways. Essentially, MACD works by smoothing out a security’s recent price movements and comparing that medium-term trendline to a short-term trendline showing its recent price changes. Traders can then base their buy and sell decisions on whether the short-term trendline rises above or below the medium-term trendline.
What is the difference between RSI divergence and RSI reversal?
RSI divergence occurs when the indicator lags behind the price, while RSI reversal signals are the result of the price lagging behind the indicator. Both divergence and reversal signals can be bullish or bearish. In a bearish divergence, for example, the price makes a higher high but the RSI makes a lower high. With a negative reversal on the other hand, RSI makes a higher high, while price makes a lower high. All in all, the RSI is one of the most popular momentum oscillators in technical analysis. It is used to measure the speed and change of price movements, giving traders insights into potential overbought and oversold conditions. Calculated using a function of relative strength, RSI ranges from 0 to 100. The RSI, with its overbought and oversold levels, actually helps traders spot potential reversals, divergences and trend continuations.
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