RSI Trading Strategy: How To Use RSI Indicator

By comparison, RSI is a measure of the strength of a stock’s momentum, either in the upward or the downward direction, and it identifies either overbought or oversold conditions. Knowing what the relative strength index (RSI) is and knowing how to read an RSI chart are invaluable tools investors can use to spot trend reversals. The formula divides the average gain the price has had over 14 periods by the absolute value of average loss. The Stochastic RSI ranges between 0 and 1, and traders often multiply the result by 100 to bring the scale to 0-100, similar to the traditional RSI. Like the traditional RSI, overbought and oversold levels can be identified using the 80 and 20 levels, respectively. While the default RSI calculation uses a 14-period timeframe, traders can adjust the period to suit their preferences and strategies.

As you can see in the above chart, the RSI indicator can stay in the overbought region for extended periods while the stock is in an uptrend. The indicator may also remain in oversold territory for a long time when the stock is in a downtrend. This can be confusing for new analysts, but learning to use the indicator within the context of the prevailing trend will clarify these issues. Then, RSI will swing back and break its most recent record high. Investors who are skilled enough to observe the signs of an approaching swing rejection may be able to capitalize on it to potentially make a profit. RSI is calculated based on average price gain and average price loss, typically in a 14-day window.

Overbought and Oversold RSI Levels

You could sustain a loss of some or all of your initial investment and should not invest money that you cannot afford to lose. All in all, the quality of RSI signals increases when you follow only those signals that are in the direction of the trend when the indicator leaves critical levels. For example, you can buy during an uptrend when RSI gets above 30. A security is considered overbought when the RSI reading is above 70 and oversold when it is below 30. Traders generally interpret the RSI line moving below the overbought line or above the oversold line as a signal to buy or sell. Knowing the asset’s primary trend is crucial for understanding RSI readings correctly.

Support and resistance levels measured by moving averages or trendlines can also be used to find levels where the market is oversold and finds support, or overbought and finds resistance. The relative strength index (RSI) is a popular momentum oscillator​​ that can be used to determine the future direction of a market. Traders can use the RSI to gauge whether momentum is accelerating or decelerating. It can also be used to evaluate whether a security is overbought or oversold. The RSI is a popular technical analysis tool and can help traders identify and generate trading opportunities in the markets.

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See our Terms of Service and Customer Contract and Market Data Disclaimers for additional disclaimers. Always do your own careful due diligence and research before making any trading decisions. However, one should not take this as a sole indication to buy (or sell) the asset in question. We will go forward to the next topic to understand the whole picture. You can see in the graph below that the RSI indicator crossed the overbought zone in July 2018 and since then, the price continued to rise indicating a bull run. You can see in the graph below that the closing price continued to rise even after entering the overbought zone from 19 March to 25 April.

Some common candlestick patterns include the hammer, doji, engulfing, and harami. The daily RSI indicator measures momentum, showing if a reversal in price is about to come or the current trend can stay longer. It considers the specified period’s daily stock gains and losses. Then, it provides a value between 0 to 100, with the equilibrium level at 50. Another way of using the RSI indicator is trying to spot potential points of price reversal. To do so, traders look for the so-called bullish and bearish divergences.

What is an RSI trading strategy?

During a bull market, RSI values normally sit in the 40 to 90 range, with the range seen as support. In a bear market, the reading typically stays within the 10 to 60 range, with the zone signaling resistance. These ranges are typical but may vary based on the settings for the index, as well as the strength of the underlying market trend for any given security. Bonds, commodities, and stocks increase and decrease in price following business cycles of economic growth and shrinkage. We can identify the point where the cycle changes from the positive side to the negative side (or vice versa) by measuring momentum, allowing you to sell the business when it is about to crash. Traders use the RSI to spot potential overbought and oversold market conditions.

However, the RSI (plotted in the lower chart window) does not follow suit and make a corresponding new low. Instead, it has already begun to turn to the upside near the beginning of June. As the chart’s subsequent price action reveals, this bullish divergence correctly forecasted an upcoming trend change, from downtrend to uptrend. The RSI was designed to help traders identify potential reactions or reversals from overbought and oversold levels.

Bearish signals during downward trends are less likely to generate false alarms. The primary trend of the security is important to know to properly understand RSI readings. For example, well-known market technician Constance Brown, CMT, proposed that an oversold reading by the RSI in an uptrend is probably much higher than 30. what is relative strength index Likewise, an overbought reading during a downtrend is much lower than 70. After the RSI is calculated, the RSI indicator can be plotted beneath an asset’s price chart, as shown below. The chart tells us that the stock spent part of October 2021 in overbought territory and entered that territory again briefly in February 2022.

On the other hand, during a downtrend, it is rare to see the RSI exceed 70; instead, the indicator frequently hits 30 or below. Together, these two conditions indicate rising bullish momentum, and a break above oversold territory could be used to trigger a new long position. The maximum value (338.5 USD) occurred on February 19th, 2020, and from that point, it started to go down, causing millions of dollars in losses for investors. Together with the 7-SMA, 20-SMA, and 50-SMA, our relative strength index calculator says yes.