Unlock the Power of RSI: Harness the Potential of Relative Strength Index to Optimize Your Trading Decisions
GPSM | Will Bell | September 28th, 2023
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Since I've been analyzing & trading stocks for decades, I've mastered many technical tools and even developed my own chart pattern that allows me to pinpoint my winning penny stock investments.
Suppose, however…, on the other hand, you're new to online trading.
Where you start on your trading path will determine how much money you will make at the end of the day and as we all know being broke sucks…, so I've put together this training article on the RSI (Relative Strength Index), how it works, and how to use it to assist you in trading.
Mastering this momentum oscillator will help you understand how to buy and sell stocks - ideally before they erupt.
It might be difficult to select the correct penny stocks that have a high probability chance of being profitable so I use Golden Penny Stock Millionaires as the Trading Newsletter of choice for high-probability penny stock alerts.
(It’s no secret that I helped developed the trading system Golden Penny Stock Millionaires uses to select stocks and that I own the platform however, the more you learn and study, the better your stock picks can become.)
Let's Dig In
Fortunes are made by buying low and selling too soon. - Nathan Rothschild
The Trading Oscillator is called The "RSI," and it means "Relative Strength Index."
But How Does It Work?
The "RSI,” means "Relative Strength Index." The relative strength index (RSI) is a momentum indicator used in technical analysis that measures the magnitude of recent price changes to determine whether a stock or other asset is Overbought or Oversold.
The RSI is represented as an oscillator (a line graph that moves between two extremes) and has a range of 0 to 100.
J. Welles Wilder Jr. created the indicator and published it in his seminal 1978 book, "New Concepts in Technical Trading Systems."
The RSI has traditionally been interpreted and used to indicate that values of 70 or higher indicate that a security is becoming overbought or overvalued and may be primed for a trend reversal or corrective price pullback.
An RSI reading of 30 or less indicates that the market is oversold or undervalued.
Important Keys To The RSI
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The relative strength index (RSI) is a well-known momentum oscillator that was created in 1978.
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The RSI provides technical traders with signals about bullish and bearish price momentum, and it is frequently plotted beneath a price graph, but in our ex. they are plotted above the price graph.
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When the RSI is above 70%, an asset is considered overbought, and when it is below 30%, it is considered oversold.
The calculation uses the average gain or loss as the average percentage gain or loss over a given time period.
The RSI Calculation Formula
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The RSI is calculated in two steps, beginning with the following formula:
RSI
RSI = 100 – [100 / ( 1 + (Average of Upward Price Change / Average of Downward Price Change ) ) ]
For the average loss, the formula employs a positive value. Periods with price losses are counted as 0 in average gain calculations, and periods with price increases are counted as 0 in average loss calculations.
The initial RSI value is typically calculated over 14 periods. Assume the market closed higher seven out of the last 14 days, with an average gain of 1%.
The remaining seven days all ended lower, with a loss of 0.8 percent on average.
The RSI Is Calculated.
Guys, the RSI can be calculated using the above formulas, and the RSI line can then be plotted beneath, or above an asset's price chart.
The RSI rises as the number and size of positive closes increase, and falls as the number and size of losses increase.
In a strongly trending market, the second part of the calculation smooths the result, so the RSI will only be close to 100 or 0 in the second part of the calculation.
As shown in the above chart, when the stock is in a bullish price uptrend, the RSI indicator can remain in the overbought region for extended periods of time. This is called Divergence.
When the stock is in a downtrend, the indicator may also remain in oversold territory for an extended period of time.
This level of divergence can be perplexing for new analysts, but learning to use the indicator within the context of the current trend will help to clarify these issues.
What Does the RSI Indicate?
The primary trend of the stock or asset is a useful tool for ensuring that the indicator's readings are correctly understood.
Seasoned traders with experience tout the idea that an oversold reading on the RSI during an uptrend is likely to be much higher than 30%, and that an overbought reading on the RSI during a downtrend is likely to be much lower than 70%.
As understood at times during a downtrend, the RSI on a chart would peak near 50% rather than 70%, which could be used by investors to more reliably signal bearish conditions.
When there is a strong trend, many investors will use a horizontal trendline between 30% and 70% to better identify extremes.
When the price of a stock or asset is in a long-term horizontal channel, modifying overbought or oversold levels is usually unnecessary.
Focusing on trade signals and techniques that conform to the trend is a related concept to using overbought or oversold levels appropriate to the trend.
In other words, using bullish signals when the price is in a bullish trend and bearish signals when the price is in a bearish trend will help to avoid the RSI's many false alarms.
RSI and RSI Ranges Interpretation
When the RSI exceeds the horizontal 30 reference level, it is considered a bullish sign, and when it falls below the horizontal 70 reference level, it is considered a bearish sign.
In other words guys, RSI values of 70 or higher indicate that a security is becoming overbought or overvalued and may be ripe for a trend reversal or corrective price pullback.
An RSI reading of 30 or less indicates that the market is oversold or undervalued.
RSI readings may fall into a band or range during trends. During an uptrend, the RSI should be above 30 and frequently exceed 70.
During a downtrend, the RSI rarely rises above 70, and it frequently falls below 30.
These guidelines can assist in determining trend strength and identifying potential reversals.
For example, if the RSI fails to reach 70 on several consecutive price swings during an uptrend but then falls below 30, the trend has weakened and may be reversing lower.
In the case of a downtrend, the opposite is true.
If the downtrend is unable to reach 30 or lower and then rallies above 70, it has weakened and may be reversing to the upside.
When using the RSI in this manner, trend lines and moving averages are useful tools to include.
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RSI Divergences In Action
A bullish divergence occurs when the RSI produces an oversold reading, which is followed by a higher low that corresponds to correspondingly lower lows in the price.
This indicates that bullish momentum is building, and a break above oversold territory could signal the start of a new long position.
A bearish divergence occurs when the RSI creates an overbought reading, followed by a lower high that corresponds to the price's corresponding higher highs.
As shown in the chart below, a bullish divergence was identified when the RSI formed lower lows while the price formed higher highs.
This was a valid signal, but divergences are uncommon when a stock is in a long-term trend that is stable.
More potential signals can be identified by using flexibly oversold or overbought readings.
RSI Swing Rejections
Another trading strategy examines the RSI's behavior as it returns from overbought or oversold territory.
This signal is known as a bullish "swing rejection," and it consists of four parts:
• The RSI has reached oversold territory.
• The RSI returns to levels above 30%.
• The RSI forms another dip but does not return to oversold territory.
• The RSI then breaks through its previous high.
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 manner is analogous to drawing trend lines on a price chart.
The swing rejection signal, like divergences, has a bearish version that looks like a mirror image of the bullish version. A bearish swing rejection has four components:
• The RSI has reached overbought territory.
• The RSI falls below 70% once more.
• The RSI creates another high without returning to overbought territory.
• The RSI then falls below its most recent low.
This signal, like most trading techniques, will be most reliable when it conforms to the prevailing long-term trend.
Bearish signals are less likely to generate false alarms during downward trends.
The RSI and MACD (Moving Average Convergence Divergence)
Another trend-following momentum indicator is the Moving Average Convergence Divergence (MACD), which depicts the relationship between two moving averages of a security's price.
The MACD is calculated by subtracting the exponential moving average (EMA) of 26 periods from the EMA of 12 periods. The MACD line is the result of that calculation.
The "signal line," a nine-day EMA of the MACD plotted on top of the MACD line, can then function as a trigger for buy and sell signals.
Traders can buy the security when the MACD crosses above its signal line and sell it when it crosses below the signal line.
The RSI was created to show whether a security is overbought or oversold in relation to recent price levels. The RSI is calculated by averaging price gains and losses over a given time period.
The time period is set to 14 by default, with values ranging from 0 to 100.
The MACD measures the relationship between two exponential moving averages (EMAs), whereas the RSI measures price change in relation to recent price highs and lows.
These two indicators are frequently used in conjunction to provide analysts with a more comprehensive technical picture of a market.
Both of these indicators measure an asset's momentum. However, because they measure different things, they can sometimes give contradictory results.
The RSI, for example, may show a reading above 70 for an extended period of time, indicating that the security is overextended to the buy side.
At the same time, the MACD may indicate that buying momentum for the security is still increasing by displaying divergence from price, either indicator may indicate an impending trend change (the price continues higher while the indicator turns lower, or vice versa).
The RSI compares bullish and bearish price momentum and displays the results as an oscillator beneath a price chart.
Its signals, like those of most technical indicators, are most reliable when they follow the long-term trend. True reversal signals are uncommon and can be difficult to distinguish from false alarms. A false positive would be a bullish crossover followed by a sudden drop in a stock, for example.
A false negative is when there is a bearish crossover but the stock suddenly accelerates upward.
Because the indicator measures momentum, it can remain overbought or oversold for an extended period of time when an asset has significant momentum in either direction.
As a result, in an oscillating market where asset prices alternate between bullish and bearish movements, the RSI is most useful.
What Is the Relative Strength Index (RSI)?
Traders use the Relative Strength Index (RSI) to assess the price momentum of a stock or other security.
The RSI's basic concept is to measure how quickly traders bid up or bid down the price of a security. This result is plotted on a scale of 0 to 100 by the RSI.
Readings less than 30 indicate that the stock is oversold, while readings greater than 70 indicate that it is overbought.
Traders will frequently place this RSI chart below the security's price chart so that they can compare its recent momentum to its market price.
What Exactly Is an RSI Buy Signal?
If a security's RSI reading falls below 30, some traders will consider it a "buy signal," implying that the security has been oversold and is thus due for a rebound.
However, the dependability of this signal will be affected by the overall context. If the security is in a significant downtrend, it may continue to trade at an oversold level for some time.
Traders in that situation may postpone buying until they see additional confirmatory signals.
What Is the Relationship Between the RSI and the Moving Average Convergence Divergence (MACD)?
Both the RSI and the moving average convergence divergence (MACD) are indicators that aim to help traders understand a security's recent trading activity, but they do so in different ways.
The MACD works by smoothing out the security's recent price movements and comparing that medium-term trend line to another trend line that shows the security's more recent price changes.
Traders can then decide whether to buy or sell based on whether the short-term trend line rises above or falls below the medium-term trend line.
