As a trader, one of my favorite signals to use is the Relative Strength Index (RSI). The RSI is a momentum oscillator that compares the magnitude of recent gains to recent losses in an attempt to discern if a particular asset is being overbought or oversold.
Overbought and Oversold RSI Levels
The RSI is usually set to look back 14 periods (whether that’s hours, days, weeks, or months) and moves between zero and 100. Generally, an RSI over 70 indicates that a market or asset is becoming overbought, and thus, the price might soon return to a more ‘normal’ level. On the other hand, an RSI under 30 usually indicates an oversold market or asset, signifying the price might be undervalued and due for a rebound.
While these are the most common thresholds, they are not the only ones used. Some traders prefer a more conservative approach and use 80/20 or 90/10 as their overbought/oversold thresholds. This favorite RSI signal has the flexibility to adjust based on the individual trader’s strategy, making it a versatile tool.
Strengths of the RSI Signal
The RSI signal serves as a reliable tool in predicting future price movements. It helps in identifying the possible peaks and troughs in an asset’s price, allowing traders to make better decisions. Armed with knowledge about possible bullish or bearish price reversals, traders can strengthen their investment strategies and minimize losses.
Furthermore, the RSI is not concerned with the absolute value of prices. Instead, it focuses on the changes in prices, meaning that it performs well in volatile markets – a condition many other types of indicators struggle with.
RSI Divergence
Another feature I particularly value in the RSI signal is its ability to signify a divergence. A divergence occurs when the market price moves in one direction, and the RSI moves in the opposite direction. This can be a reliable signal for the end of a current trend, and it’s incredibly helpful in a trader’s arsenal – I can’t tell you how many times it has saved me from being on the wrong side of a trend.
A bullish divergence is identified when the price creates a lower low, but the RSI creates a higher low. This is usually a good sign that the price is about to move upward. Conversely, a bearish divergence occurs when the price creates a higher high, but the RSI creates