Monday, October 30, 2017

What is RSI or Relative Strength Indicator

What is RSI?

RSI stands for Relative Strength Indicator. It is a momentous oscillator used to identify trend reversal


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Who invented RSI ?
RSI was invented by Welles Wilder Jr.
What is concept of RSI? RSI calculates strength of stock trend and helps to predict their reversals. RSI value oscillates between 0 to 100. As per Wilder when RSI value is above 70 its is considered as overbought and when RSI is below 30 it is considered as oversold. Some traders use 75/25 or even 80/20 to define overbought and oversold.
A value between 35 to 65 is a no entry or exit point for traders who rely on RSI as primary indicator. However their movement can help supplement other indicators signal. Another use of RSI is to determine divergence between price and RSI. Divergence indicates trend reversals.

Divergence:
A divergence is formed when

a. In a downtrend RSI is making higher high and higher lows while price is making lower high and lower lows.
b. In a upward trend RSI is making lower high and lower lows while price is making higher high and higher lows.
Uses of RSI
1.Identify overbought stocks.
2.Identify oversold stocks.
3.Identify trend reversals.
4.Identify direction of the trend .
5.Excellent tools for swing traders .

Tips to trade with RSI.
1. A general rule of buying when RSI moves from below 30 to above with combination of another indicator like rise in volume or Moving average crossover or any other indicator of your choice.
2. A general rule of selling when RSI moves from above 70 to below with combination of another indicator like rise in volume or Moving average crossover any other indicator of your choice.
3. When RSI trend is falling and price trend is rising and RSI is in overbought state then a reliable sell signal is generated.
4. When RSI trend is rising and price trend is falling and RSI is in oversold state then a reliable buy signal is generated.
5. For those who use end of the day data may profit from RSI in 1-7 days or more days.

6. Less risky traders should wait for RSI move above 30 from below 30 to take a position. Aggressive traders sometimes even take 35/65 as oversold and overbought range.
7. RSI values can be altered for different types of stocks. For extremely stable stocks or small price ranging stocks a value of 35 may be a good entry point and for highly volatile stock a value of 25 may even be considered as high risk.
8. Trend reversal at 70 /30 is considered to be 75% accurate.
9. Trend reversal for divergence is considered to be about 80% accurate.
Divergence looses its significance in sideways market.

Warning :-
a. Buying stock just based on its value below 30 may lead to losses. In stock down trend RSI may stay below 30 for long time with continuous fall in price.
b. Similar to aforementioned point selling just based on RSI above 70 may reduce your profit.

c. In extremely strong trend , RSI can yield wrong results.
d. In some cases RSI and price divergence can last for longer time before trend reversal. Traders needs to be patient with it.
e. Not all stock movement will generate RSI buy/sell signals
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