What is the 'Relative Strength Index – RSI?
The relative strength index (RSI) is a momentum indicator created by noted technical analyst Welles Wilder. It measures the speed and change of price movements by comparing the magnitude of recent gains and losses over a specified period. Its primary use is to identify overbought or oversold conditions in the trading of an asset.
What makes it a momentum indicator is that it provides an evaluation of the strength of a security's recent price performance in a relative way.
Overbought and Oversold in RSI.
The standard interpretation of the RSI is that RSI values of 70 or higher show that a security is becoming overvalued or overbought, and there may be a corrective pullback in price or a trend reversal.
On the other hand, an RSI reading of 30 or under is usually read as a signal of undervalued or oversold conditions that may signal a trend change or corrective price reversal to the upside.
Think Beyond the Crossovers.
When traders first learn about RSI and other oscillators, they tend to gravitate to overbought and oversold values. But, these are intuitive points to get into the market on retrenchments and can be a mistake in robust trending environments.
That means extended trends can keep RSI overbought or oversold for long periods of time.
RSI is not different from mostly oscillator with a centerline found in the middle of the range at a reading of 50. It becomes a white crayon in a pencil case compared to the indicator itself.
The centerline is used by Technical traders to show shifts in the trend. If RSI is above 50, it means opportunities to buy the market. A drop below 50 would indicate the development of a new bearish market trend.
Like many other oscillators, RSI defaults to a 14-period setting. That means the indicator looks back 14 bars on whatever graph you may be viewing, to create its reading.
Despite 14 being the default setting, it is not always the best setting for your trading.
The use of a smaller period is regular among short-term traders, such as a 7 period RSI, to create more indicator oscillator. On the other hand, a higher period, such as a 25 period RSI, is opted for longer-term traders for a mother indicator line.
What are other useful tools to use with the Relative Strength Index (RSI)?
As the name implies, RSI simply measures the relative strength of the underlying market. Identifying reversals using RSI, it is necessary to add other tools like candlestick analysis or trend line analysis.
A typical example of this is if RSI is diverging while you are reading a reversal candlestick near a trend line, then you have a trading opportunity being generated.
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