About the RSI indicator

There are many investment tools out there to help you invest your money more wisely. The RSI indicator is just one of those tools. The RSI indicator or Relative Strength Index is also known as a price-following oscillator. It’s unique content is an indicator of how fast the price changes for a particular security or currency. Basically, it follows the price changes for a particular security over a set period of time. From these price changes, we can better determine if a security has reached it’s peak or will it fall. Basically, it measures the magnitude of the recent gains to the recent losses. With this information you can determine if the security is overvalued (and likely to fall) or undervalued (likely to rise). However, remember this is all relative.

The RSI is calculated as such: the RSI = 100 / (1 + D(P,n)/U(P,n)), where U(P,n) – is a moving average of the rising of the “P” (price) within “n”, (time) periods, D(P,n) – is a moving average of falling of the “P” (price) within “n” (time) periods. Popular periods of time can vary from from 9 days to 25 days. Fourteen days are the most popular although most technical traders use a 10 day period. By using the formula above, this indicator trades between value lines of 0 and 100. The oversold line is normally at 30 (and below) and overbought line at 70 (and above). Touching or exceeding these two zones are warning signs of a very possible market reversal. Of course, you would like the price to move out of those zones before making a transaction.

Be aware that reaching those line indicators does not automatically mean you should buy or sell. Again, it just indicts whether it is over sold or over brought. The market could stay at the 30 or 70 level for an indefinite period of time. However, if a value reaches at or above 90%, that would likely indicate an overbought condition that should trigger a selling signal. Conversely, a result under 10% shows an oversold condition. This should trigger a buy signal.

There is another way to use the RSI indicator and that is by looking for divergence signals. Divergence signals are moving back towards those zones we talked about earlier. For instance, if the RSI reaches 30 look for bullish divergence, a slowly rising RSI against the still declining prices. Here again, the same would be true as we approach the 70 level except that we would have a bearish divergence. The RSI divergence hints to us that current momentum is over. At this point, traders should look to protect their profits and be ready to trade in the opposite direction. Divergence does not occur at every turning point but at significant turning points.

Please note that as with all technical analysis tools, the RSI should not stand alone. It should be used in together with other tools to offer a more solid trading decision for traders like you to enter into new trades or protect profits already gained.

Happy Trading!