Trading using RSI: A Beginner’s Guide
Trading may be fun and rewarding, but you need to know your indicators and tools. The Relative Strength Index (RSI) is a technical indicator traders use to assess asset strength and momentum. This article will discuss RSI’s computation, interpretation, and trading use.
RSI represents relative strength.
J. Welles Wilder’s momentum oscillator, the Relative Strength Index, is used in technical analysis. It indicates if a financial instrument is overbought or oversold by measuring price movement speed and change. A line chart that oscillates above and below a midline shows RSI on a scale of 0 to 100.
Calculating RSI
The formula for RSI is:
RSI = 100 – (1 + RS)
The average gain of up-period closures divided by the average loss of down-period closes over a specific time period yields RS (Relative Strength). The default look-back time for RSI is 14 periods, but traders may alter it to suit their needs and the asset being evaluated.
Interpreting RSI
From 0 to 100, RSI values over 70 indicate overbought circumstances and below 30 oversold conditions. When the RSI crosses over 70, the asset may correct or reverse downward. When the RSI dips below 30, the asset may be oversold and ready to rise.
Trading using RSI
RSI may be used in several trading strategies:
1. Levels of Overbuying and Selling
As previously noted, RSI readings above 70 and below 30 imply overbought and oversold levels. When the RSI approaches these extreme zones, traders may take gains or start a contrarian trade to predict a trend reversal. In strong trends, overbought and oversold circumstances may last for a long time.
2. Divergent RSI
Divergence happens when asset prices move against the RSI. Price and RSI produce a lower low and higher low, respectively, indicating bullish divergence. This shows an upward trend reversal. Bearish divergence happens when the price makes a higher high and the RSI makes a lower high, signaling a negative trend reversal. As RSI diverges, traders may enter or leave positions.
3. RSI Trendline Break
Trendlines on the RSI chart might help traders spot breakouts. An RSI break above a declining trendline suggests a positive trend reversal. When the RSI breaks below an ascending trendline, a bearish trend reversal may occur. Trendline breakouts may corroborate technical analysis signals and enhance trading choices.
Sources and Links
Sources providing RSI information include:
https://en.wikipedia.org/wiki/Relative_strength_index
https://www.investopedia.com/terms/r/rsi.asp
https://www.tradingview.com/support/solutions/43000501829-relative-strength-index-rsi/