The Relative Strength Index (RSI) is a technical indicator that measures the magnitude of recent price changes to help identify overbought or oversold conditions in the market. The RSI indicator is displayed as an oscillator and ranges from 0 to 100. Readings below 30 may indicate an oversold condition, while readings above 70 may indicate an overbought condition.
The RSI is calculated using the following formula:
RSI = 100 – 100/(1 + RS)
where RS = Average Gain / Average Loss
Wilder originally recommended a 14-day RSI. However, since then, shorter and longer timeframes have been used with varying results.
Trading with RSI:
The basic premise of using the RSI as a trading signal is that when the indicator is overbought, prices are likely to fall, and when it is oversold, prices are likely to rise.
There are a number of different ways that traders can enter or exit trades using the RSI. One of the most common is to buy when the RSI crosses above its oversold threshold (usually 20 or 30) and sell when it crosses below its overbought threshold (usually 70 or 80). Another popular method is to enter a long position when the RSI crosses above 50 and exit when it falls below 50.
There are a number of other ways to trade with the RSI, and traders can experiment with different techniques to see what works best for them.
One thing to keep in mind when using the RSI is that it is a momentum indicator, which means that it is subject to false signals. As such, it is often used in conjunction with other technical indicators, such as support and resistance levels, to confirm trading signals.
How to Buy and Sell Using RSI
Now that we know how the RSI works, let’s look at how to trade using this popular technical indicator.
As mentioned earlier, one of the most common ways to trade with the RSI is to buy when it crosses above its oversold threshold and sell when it crosses below its overbought threshold.
For example, let’s say that we are looking at a 14-day RSI. We might enter a long position when the RSI crosses above 20 and exit when it falls below 20. Similarly, we might enter a short position when the RSI crosses below 80 and exit when it rises above 80.
Another common method is to enter a long position when the RSI crosses above 50 and exit when it falls below 50.
This method is often used in conjunction with support and resistance levels. For example, let’s say that the price is trading near a support level and the RSI is above 50. This might be seen as a bullish signal, and we might enter a long position at the support level with a stop loss below the support level.
Conversely, if the price is trading near a resistance level and the RSI is below 50, this might be seen as a bearish signal, and we might enter a short position at the resistance level with a stop loss above the resistance level.