RSI: Relative Strength Index - Definition
The Relative Strength Index (RSI) is an extremely popular momentum indicator, perhaps the most well-known one by J. Welles Wilder. RSI provides various signals about trends and trend direction changes. However, most traders use it to spot overbought (the price has become too high and may be headed for a fall) or oversold (the price has become too low and may be headed back up) market conditions.
- The RSI is calculated in the following way: RSI = 100 - 100 / (1 + RS)
- Where RS = Average Gain / Average Loss
RSI values range between 0 - 100, and like most oscillators, has overbought and oversold areas. Common usage of the indicator is that RSI values of 70 or above indicates that an instrument is becoming overbought, and therefore may highlight a trend reversal. On the other hand, RSI values at 30 or below commonly indicates an oversold condition that may signal a trend change or corrective price reversal to the upside. These values, however, can be amended by the trader.
According to Wilder the RSI default setup is 14 periods. Traders may change this value depending on how sensitive and fast they want to get the indicator to react to the market.
RSI is a momentum indicator but also easy to use for determining the trend. When RSI drops below 50 the market is considered bearish, and if it rises above 50 the market is considered bullish. As an oscillator, the RSI has its own movement/trends and can form lows and highs. In this sense, the indicator can be used for finding divergences between the price and the indicator data.
The bearish divergence occurs when the RSI is in the overbought area and prints lower peaks while at the same time in the price chart there is a higher high printing. The bullish divergences occur when the RSI is in the oversold area and prints higher lows chart while at the same time in the price chart there is a lower low printing.
It’s also possible to use RSI chart patterns alone to influence trading decisions within your Skilling account. It’s not uncommon for an RSI indicator to be showing potential price patterns that are yet to be replicated on the price chart of the underlying asset. These patterns include trend lines as well as double tops and double bottoms on bearish and bullish markets respectively.
In terms of common ranges for an RSI, when an asset is experiencing a bullish uptrend, it’s common for the RSI to trend within a range of between 40-90. When it touches the range of 40-50, many traders are likely to go long on an asset then as there’s plenty of potential upside. During bearish downtrends, an RSI will typically range between 10-60. When it touches the 50-60 range, many traders are expected to go short on an asset given the potential for lots of upside movement downwards.
It's not uncommon for the price of an underlying asset to reach new lows or highs that weren’t anticipated or confirmed by the RSI indicator. This divergence away from the RSI range can often lead to a reversal in its value shortly afterwards. Aside from using RSI to learn whether an asset is overbought or oversold, there are several other nuggets of information you glean from this indicator.
First and foremost, you can identify ‘failure swings’ which occur when the price of an asset hits new lows, but the RSI doesn’t follow suit and moves above the recent swing high – also known as ‘fail point’ – of the indicator instead. This is commonly known as a signal to buy the asset in question.
The middle 50 line on an RSI also helps to define the medium-to-long-term price direction on an asset. If it regularly sits above the middle 50 line, it is assumed that the asset is in a bullish trend. If it sits below 50 and regularly gets resistance when it moves toward the middle 50 line, it is in a bearish trend. Ultimately, the middle 50 line can help identify a shift in momentum – sometimes before the price on the underlying asset has followed suit.
RSI trading strategies
There is a popular trading strategy that involves RSI and Bollinger Bands. The latter are an alternative technical indicator for market momentum, displaying two standard deviations above and below the simple moving average (SMA). When the value of an asset hits the top Bollinger Band, it’s often a signal that it’s overbought, while assets are often oversold when they hit the bottom Bollinger Band.
RSI and Bollinger Bands can be paired together to reaffirm potential trends upwards or downwards. Whenever the price of an asset hits the bottom Bollinger Band and the RSI sits beneath 30, it is considered oversold in both indicators. This often results in a price retraction upwards. Whenever the price of an asset hits the top Bollinger Band and the RSI sits above 70, it is considered overbought in both indicators, often driving a price retraction downwards.
RSI for day trading or other trading styles
RSI can prove particularly beneficial for day traders. If you’re looking to use RSI for day trading, be sure to change the default setting of 14 periods that medium-term swing traders often use. That’s because day traders generally feel 14 periods don’t offer sufficient updates and trading signals for short-term price movements. Reduced RSI settings with 9-11 periods are most popular among intraday traders. Those at the other end of the spectrum looking to take a long-term approach to market entries on precious commodities like gold will want to increase the RSI settings to between 20-30 periods.
How to add RSI to the Skilling trading platform
Adding RSI to your Skilling trading platform is simple:
- Type RSI into the indicator dropdown menu and select RSI.
- The screen settings for the RSI are now displayed. You can use the default input data or enter your own.
- Click the OK button to add the RSI to your trading platform.
The Relative Strength Index is extremely popular and we would even go so far as to say it is in the top ten of indicators - used by numerous traders of all levels. It is easy to understand as an oscillator...if it is above 70 then the market may be too high, and if it is below 30 the market may be too low. This simplicity is what traders love about it. Of course, you should always tweak and play around with different settings to find one that suits you. But we believe that the RSI is one that you should definitely explore at some point.
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