The RSI indicator and RSI day trading strategies are beneficial to many traders, all over the world, and in various financial markets.
The RSI indicator has proven itself to be a significant trading tool since the late 1970s. It’s no wonder we should take the time to acknowledge and talk about it!
But before we get ahead of ourselves and discuss RSI trading strategy, we must take the time to learn and understand the RSI indicator.
Technical indicators have been developed over the years to help traders navigate the market atmosphere. The financial markets can surely be unpredictable at times, especially for retail investor accounts.
Placing a trade order using trading strategies combined with a technical trading system provides the confluence profitable traders seek to be successful over a series of trades.
There are many free technical indicators available on trading platforms. The important aspect is to know what they are used for to understand and apply the information they are conveying about current market conditions.
The Birth of RSI: Relative Strength Index
RSI is an acronym for relative strength index. It was developed by J. Welles Wilder Jr. around 1978.
Wilder was a brilliant man. He served in the US Navy, achieved a degree in mechanical engineering, was a real estate developer, and authored numerous books related to finance and trading.
Among these great achievements, Wilder was most known for his technical analysis. He invented several technical indicators which include the average true range, directional movement index, parabolic stop and reverse, and the relative strength index or RSI. These trading systems were published in his book, “New Concepts in Technical Trading Systems”.
Though the RSI indicator was unveiled in the late 1970s, it is still used today in diverse financial markets such as the stock market and forex market by day traders all around the globe!
What is the RSI
Wilder developed the RSI indicator is an oscillator that can help predict price behavior. It compares an asset’s strength on days when price movement goes up as well as down, and then relates this comparison to price action.
In other words, the RSI indicator uses the speed and magnitude of price fluctuation to measure price changes. This information can evaluate an asset’s overbought or oversold conditions, giving an investor an idea of how the asset may perform.
The RSI indicator is beneficial for spotting possible trend reversals, corrective pullbacks, as well as overbought and oversold levels. Some intraday traders rely on the relative strength index indicator and RSI trading strategies for buy and sell signals as well.
It is important to note that the RSI indicator best performs in ranging markets, as opposed to markets that are trending. Also, most traders do not rely on the information of one technical indicator alone for trading signals. It is important to have other means of confirmation, such as the 200 EMA or levels of support and resistance, before entering a trade.
RSI Formula and RSI Indicator Settings
There is a two-part mathematical formula to determine the RSI indicator that utilizes 14 periods of data. Yes, you can easily look this information up and try to figure it out. Luckily, trading platforms do the work for you and contain a default RSI setting.
To gauge performance, a beginner trader may use the default RSI settings as is and test it out via paper trading on the financial asset they wish to trade. Experienced traders may see the need to adjust the settings and customize them according to their trading style, such as using a shorter 10-day period.
Each trading platform, such as TradingView or thinkorswim, may display the RSI line or zones in different colors. Be sure to look at the settings and visibility to understand how the information is displayed. Once again, you can customize these if you desire, so they are visually easier for you to grasp.
RSI Indicator Information
The RSI indicator can provide a trader with several pieces of valuable information relative to price movements on an asset’s chart. Let’s go over some highlights, so you have a better understanding of how to utilize the indicator’s information.
Overbought and Oversold Levels
The RSI indicator is displayed as an oscillator or a line graph that moves between two extreme values. These values are zero to one hundred.
A value of 70 or above on the indicator could signal an overbought market condition. A value of 30 or below on the indicator can signal oversold levels.
A market can be overbought or oversold when the price movements are too far away from an average value in either direction.
For example, let’s say there is a bullish trend line present, meaning higher highs and higher lows are being created. The RSI reflects a value of 70 or higher which is considered the overbought zone.
At this point, the asset appears overvalued. When this occurs, the price will eventually snap back or drop close to the actual average or intrinsic value. This concept is referred to as means reversion.
The same occurs when an asset’s price moves so low that the RSI line produces an oversold reading or has a value of 30 or lower. The asset is now considered undervalued, and the price will possibly revert up to a higher average value.
Divergence occurs when two pieces of data directionally conflict. For example, when the RSI indicator is moving in the opposite direction of price, divergence is present.
The RSI indicator can display bullish divergence or bearish divergence. These kinds of divergences can relay possible future trend reversals or temporary market pullbacks.
Bullish Divergences: When the price formed lower lows, but the RSI formed higher lows, bullish divergence conditions existed. What that tells a trader is that the strength of the asset’s bearish trend or downtrend in price is fizzling and that a move to the upside may soon take place.
Bearish Divergences: When the price forms higher highs but the RSI creates lower highs, we have bearish divergence. The conflicting data tells a trader that buyers may be losing steam. The existing bullish trend will possibly soon end, and bearish price momentum will take over.
Trending RSI Values
It is important to know what the RSI looks like in trending markets to avoid false signals. Though it performs best in ranging markets, it can also confirm a trend and give us possible hints of price cool-offs.
When the value of the RSI indicator is 70 or above, this is considered the overbought territory. If the RSI remains in that range for an extended period, the information being conveyed is that the asset’s price is in a bullish trend.
When the value of the RSI indicator is 30 or below, this is considered an oversold reading. Traders may look for oversold signals to buy at a low price and trade long positions. However, if the RSI remains in this range for a period of time, the market is in a bearish trend.
In both circumstances, the trend is evident. Price and the RSI are moving in the same direction and in or range close to the overbought and oversold levels.
When the price is trending, it is important to not rely on the RSI to produce an accurate buy signal or sell signal based only on an overbought or oversold reading. A trader should await evidence of RSI divergences or rely on RSI support or resistance to be retested before confirming bullish and bearish movements.
Summary: RSI Day Trading
The RSI or relative strength index is a technical indicator that measures price movements in relation to the speed and momentum of price changes for that given asset.
It can tell us when the market conditions appear to be overbought or oversold, signal divergence to depict trend reversals, and also confirm when the value of a stock is trending.
Understanding the RSI indicator can be beneficial and help day traders predict price behavior.
Like other technical indicators, the RSI signals should not be relied on solely for trade implementation. Seeking confirmation by other indicators and trading strategies produces the best results.
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