How to Use Relative Strength Index
The Relative Strength Index (RSI) is a widely used momentum oscillator in technical analysis. It helps assess the strength and speed of price movements of a financial asset. J. Welles Wilder developed it in 1978. In this article, you will learn how to read RSI correctly and make it your go-to tool for trading.
What is RSI?
RSI oscillates between 0 and 100 and is usually displayed as a line graph. It is commonly used with a 14-day timeframe. However, the number of days can be adjusted based on your preference or analyzed asset.
How is it calculated?
The RSI is calculated using the formula: RSI = 100 – (100 / (1 + RS))
Where RS = Average of X days’ up closes / Average of X days’ down closes.
How to read RSI?
The RSI is an overbought/oversold indicator. If the RSI is above 70, it may indicate that the asset is overbought, and a potential reversal or correction could occur. On the other hand, if the RSI is below 30, it suggests that the asset is oversold, and a potential rebound or rally could happen.
How to use RSI in your trading?
You can use the Relative Strength Index (RSI) in many ways to improve your trading results:
Identify overbought and oversold levels. RSI values above 70 are generally overbought, indicating a possible price correction or reversal. RSI values below 30 are typically oversold, suggesting a potential price rebound or rally. These levels vary depending on the market and timeframe, so it’s essential to consider the asset characteristics.
Spot divergences. Divergence happens when the RSI indicator and the asset’s price move in opposite directions. Bullish divergence happens when the price forms lower lows while the RSI forms higher lows, indicating potential upward momentum. A bearish divergence occurs when the price forms higher highs while the RSI forms lower highs, suggesting potential downward pressure. Divergence can be a useful signal for potential trend reversals.
Confirm trend strength. The RSI can help confirm the strength of a trend. In a strong uptrend, the RSI tends to stay in the overbought region for a sustained period. In a strong downtrend, the RSI tends to remain in the oversold region for an extended period. Monitoring the RSI alongside price movements can provide insights into the strength or weakness of a trend.
Use RSI as a signal generator. Traders often use the RSI to generate buy or sell signals. When the RSI crosses above the oversold level (e.g., 30), it may be considered a buy signal. Conversely, when the RSI crosses below the overbought level (e.g., 70), it may be seen as a sell signal. However, it’s important to consider other factors and use additional confirmation before making trading decisions solely based on RSI signals.
Consider timeframe. The RSI can be used on different timeframes, such as daily, hourly, or even shorter intervals. Shorter timeframes may generate more frequent signals, but they can also be more prone to false signals. Longer timeframes may provide more reliable signals but with fewer opportunities. Choose a timeframe that aligns with your trading strategy and objectives.
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