Any successful trader will tell you that it’s important to have good tools in your trading toolbox if you want to be successful. One of the most common tools used by traders is known as the Relative Strength Index or RSI.
What Is The Relative Strength Index (RSI)?
The Relative Strength Index is a momentum oscillator developed by J. Welles Wilder. The RSI measures the speed of change of price movements in the market, oscillating between zero and 100. A stock with an RSI above 70 is viewed as overbought and below 30 is viewed as oversold.
What Is The Relative Strength Index Used For When Trading?
By looking for divergences and failure swings, traders can use the RSI to generate buy and sell signals. This tool is also commonly used as a way to identify a general trend.
What Does It Mean For A Stock To Be Overbought?
An overbought stock is a stock with an RSI that is above 70. This indicates that there are too many buyers and not enough sellers. As a result, a correction may be on the horizons, leading to declines.
What Does It Mean For A Stock To Be Oversold?
An oversold stock is a stock with an RSI that is below 30. These stocks are generally nearly support and are likely to see a reversal in the upward direction soon.
How To Use The RSI To Your Advantage
Overbought And Oversold Adjustments – Traditionally, a stock is considered overbought when it has an Relative Strength Index of over 70 and oversold when the Index falls below 30. However, these lines may need to be adjusted. If a stock is repeatedly reaching an RSI of 70 or 30 with little time between, the indicator may not work as a good trading signal. Therefore, you may want to adjust the overbought parameters to 80 or the oversold parameters to 25. It’s also important to note that during a strong trend, the Relative Strength Index may remain in overbought or oversold territory for an extended period of time.
Once you have the parameters dialed down, seeing an oversold RSI could signal an uptrend ahead while an overbought RSI could signal a downtrend. Use this knowledge to your advantage when making your trades.
Hidden Patterns – The RSI can also be used to show the trader patterns that may otherwise be hidden on the price chart. Most importantly, these patterns include double tops and bottoms as well as trend lines like support and resistance. Double tops and resistance are often signs of declines to come while double bottoms and support are often signs of coming gains. Keep this in mind when trading.
Finding Support And Resistance In Bull And Bear Markets – In general, the RSI can be used to find support and resistance during bull and bear markets. Here are the basics in doing so:
- Bull Market/Uptrend – During a bull market, the indicator will generally stay between 40 and 90. In this particular case, when it reaches the zone between 40 and 50, it is commonly considered to be a support zone during a bull market or uptrend.
- Bear Market/Downtrend – During the bear market, the RSI will usually stay between 10 and 60. In this market, the range between 50 and 60 is generally considered to be resistance.
Confirmation – The RSI confirmation is a great way to find reversals. In general, if underlying prices make new highs or new lows that are confirmed by highs or lows in the Index, the divergence can prove to be a signal of price reversal. However, you may see swing failures as well. For example, if a stock’s Relative Strength Index makes a lower high then moves below previous lows, this is considered to be a Top Swing Failure. Adversely, when the RSI makes a higher low and moves upward further than previous highs, a Bottom Swing Failure has taken place.
Have Questions? Join The Discussion Below!
If you have any further questions about how an RSI works or how to use it to your advantage, don’t be shy! Ask your question in the comments below and an iWatch Markets representative will respond to your question shortly! Also, consider reading more within our Investing 101 Series to learn how to become a more successful investor or trader!