Relative Strength Index (RSI)

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What Is the Relative Strength Index (RSI)?


The relative strength index (RSI) is a momentum indicator used in technical analysis that measures the magnitude of recent price changes to evaluate overbought or oversold conditions in the price of a stock or other asset. The RSI is displayed as an oscillator (a line graph that moves between two extremes) and can have a reading from 0 to 100. The indicator was originally developed by J. Welles Wilder Jr. and introduced in his seminal 1978 book, “New Concepts in Technical Trading Systems.”

Traditional interpretation and usage of the RSI are that values of 70 or above indicate that a security is becoming overbought or overvalued and may be primed for a trend reversal or corrective pullback in price. An RSI reading of 30 or below indicates an oversold or undervalued condition.

The relative strength index (RSI) is a popular momentum oscillator developed in 1978.
The RSI provides technical traders with signals about bullish and bearish price momentum, and it is often plotted beneath the graph of an asset’s price.
An asset is usually considered overbought when the RSI is above 70% and oversold when it is below 30%.

What Does the Relative Strength Index (RSI) Tell You?


The primary trend of the stock or asset is an important tool in making sure the indicator’s readings are properly understood. For example, well-known market technician Constance Brown, CMT, has promoted the idea that an oversold reading on the RSI in an uptrend is likely much higher than 30% and that an overbought reading on the RSI during a downtrend is much lower than the 70% level.1

As you can see in the following chart, during a downtrend, the RSI would peak near the 50% level rather than 70%, which could be used by investors to more reliably signal bearish conditions. Many investors will apply a horizontal trendline between 30% and 70% levels when a strong trend is in place to better identify extremes. Modifying overbought or oversold levels when the price of a stock or asset is in a long-term horizontal channel is usually unnecessary.

A related concept to using overbought or oversold levels appropriate to the trend is to focus on trade signals and techniques that conform to the trend. In other words, using bullish signals when the price is in a bullish trend and bearish signals when a stock is in a bearish trend will help to avoid the many false alarms that the RSI can generate.

Interpretation of Relative Strength Index (RSI) and RSI Ranges


Generally, when the RSI surpasses the horizontal 30 reference level, it is a bullish sign, and when it slides below the horizontal 70 reference level, it is a bearish sign. Put another way, one can interpret that RSI values of 70 or above indicate security is becoming overbought or overvalued and may be primed for a trend reversal or corrective price pullback. An RSI reading of 30 or below indicates an oversold or undervalued condition.

During trends, the RSI readings may fall into a band or range. During an uptrend, the RSI tends to stay above 30 and should frequently hit 70. During a downtrend, it is rare to see the RSI exceed 70, and the indicator frequently hits 30 or below. These guidelines can help determine trend strength and spot potential reversals. For example, if the RSI can’t reach 70 on a number of consecutive price swings during an uptrend, but then drops below 30, the trend has weakened and could be reversing lower.

The opposite is true for a downtrend. If the downtrend is unable to reach 30 or below and then rallies above 70, that downtrend has weakened and could be reversing to the upside. Trend lines and moving averages are helpful tools to include when using the RSI in this way.

Example of Relative Strength Index (RSI) Divergences


A bullish divergence occurs when the RSI creates an oversold reading followed by a higher low that matches correspondingly lower lows in the price. This indicates rising bullish momentum, and a break above oversold territory could be used to trigger a new long position.

A bearish divergence occurs when the RSI creates an overbought reading followed by a lower high that matches corresponding higher highs on the price.

As you can see in the following chart, a bullish divergence was identified when the RSI formed higher lows as the price formed lower lows. This was a valid signal, but divergences can be rare when a stock is in a stable long-term trend. Using flexibly oversold or overbought readings will help identify more potential signals.

Example of Relative Strength Index (RSI) Swing Rejections


Another trading technique examines the RSI’s behaviour when it is reemerging from overbought or oversold territory. This signal is called a bullish “swing rejection” and has four parts:

The RSI falls into oversold territory.
The RSI crosses back above 30%.
The RSI forms another dip without crossing back into oversold territory.
The RSI then breaks its most recent high.
As you can see in the following chart, the RSI indicator was oversold, broke up through 30%, and formed the rejection low that triggered the signal when it bounced higher. Using the RSI in this way is very similar to drawing trend lines on a price chart.

Like divergences, there is a bearish version of the swing rejection signal that looks like a mirror image of the bullish version. A bearish swing rejection also has four parts:

The RSI rises into overbought territory.
The RSI crosses back below 70%.
The RSI forms another high without crossing back into overbought territory.
The RSI then breaks its most recent low.