Relative Strength Index (RSI)
A technical indicator
developed by Welles Wilder to help investors gauge the current
strength of a stock's price relative to its past performance. The
usefulness of this indicator is based on the premise that the RSI
will usually top out or bottom out before the actual market top or
bottom, giving a signal that a reversal or at least a significant
reaction in stock price is imminent.
RSI readings above 70
indicate the shares are overbought and are likely to start
falling. Readings below 30 indicate the shares are oversold and a
rally can be expected. The time period specified determines the
volatility of the RSI. For example, a 9-day time period will be
more volatile than a 21-day time span.
When using Investor
charts to study RSI, you can select whatever time period works
best for your investing strategy.
purpose of the RSI is to measure the marketís strength and
weakness. A high RSI, above 70, suggests an overbought or
weakening bull market. Conversely, a low RSI, below 30, implies an
oversold market or dying bear market. Additionally, the value of
50, can serve the same purpose as the zero line in other
oscillators. The slowing down of a current trend or a trend
reversal may be signaled by crossing above or below 50.
the RSI is above 70 or buying when the RSI is below 30 can be an
expensive trading system. A move to those levels is a signal that
market conditions are ripe for a market top or bottom. It does not
indicate a top or a bottom. A failure swing or divergence
accompanies your best trading signals.
While the RSI
can be used as an overbought and oversold study, it works best
when a failure swing occurs between the RSI and market prices. For
example, the market makes new highs after a bull market setback,
but he RSI fails to exceed its previous highs.
Another use of
the RSI is divergence. Market prices continue to move higher/lower
while the RSI fails to move higher/lower during the same time
period. Divergences may occur in a few trading intervals, but true
range divergence usually requires a lengthy time frame, perhaps as
much as 20 to 60 trading intervals. When the RSI begins to fall
below the trough formed by a double-top, this may indicate a trend
reversal and a buy signal. A double-bottom in the RSI with
penetration upward may signal an opposite trend reversal and a
exhibits chart formations as well. Common bar chart formations
readily appear on the RSI study. They are trendlines, pennants,
flags, head and shoulders, double tops and bottoms, and triangles.
Plus, the study can highlight support and resistance zones.
Support and resistance zones often show up clearly on the RSI
before becoming clear on the bar chart. Many analysts draw support
and resistance lines based on the RSI in the same manner as they
would draw trendlines on a chart.
The daily bar
chart is the most common chart expression for the RSI. In
addition, you may plot a weekly chart to confirm the RSI
indications on a daily chart; weekly charts offer more
significance when tracking trending activity.