The RSI is one of the most frequently used technical indicators by both private and professional traders. Its ease of use and added value when trading the markets make it the key tool of any trader or technical analyst.
What is the RSI indicator?
The Relative Strength Index (RSI) refers to a technical momentum indicator that measures the strength of recent price movements in order to identify oversold or overbought conditions of a financial asset. It was developed by J. Wilder in 1977.
The RSI is an oscillator that evolves between 0 and 100, but very rarely reaches these extreme values, as we will see later.
How the RSI Indicator works
How does one read or interpret the RSI?
The RSI is considered overbought when it is above 70 and oversold when it is below 30. These traditional levels can also be adjusted if necessary to better match the market. For example, if a security repeatedly reaches the overbought level of 70, it is possible to adjust this level to 80. This is particularly useful on overly volatile assets such as cryptocurrencies. It should be noted, however, that in strong trends, the RSI may remain overbought or oversold for extended periods.
The RSI indicator also often forms graphical models that may not appear on the price chart, such as double peaks and troughs, or trend lines. It is also possible to find support or resistance levels on the RSI.
In a bull market or an uptrend, the RSI indicator tends to stay within the 40 to 90 range, with the 40 to 50 area serving as support. During a downtrend or a bear market, the RSI tends to remain between 10 and 60, with the 50 to 60 zone acting as resistance. These ranges may vary depending on the RSI parameters and the strength of the market trend.
If the stock market prices reach a new high or low not confirmed by the RSI, ie the indicator does not follow the price movement, we are faced with RSI divergence, which can signal a price reversal.
Trading with the RSI Indicator
How does one use the RSI indicator? How does one trade with the RSI?
The most common use that is made of the RSI indicator by traders, is the identification of reversal signals.
This RSI strategy involves examining the behaviour of the indicator when it leaves the overbought or oversold area. This RSI signal has four phases:
1. The RSI falls into oversold territory under 30.
2. The indicator goes back above 30.
3. The RSI forms another low without returning to oversold territory.
4. The RSI index then surpasses its last peak.
An RSI trader can enter a buy position upon the return above the 30 level, or he can wait for a pullback before positioning himself.
The reverse scenario involves the following phases:
1. The RSI goes into overbought territory above 70.
2. The indicator falls below 70.
3. The RSI indicator forms another peak without returning to overbought territory.
4. The RSI breaks through its last low.
Also, it is possible to enter the market at the first signal, or wait for confirmation.