RSI is a momentum indicator that measures a stock’s strengths and
weakness, in terms of a comparison of up-days versus down-days. When
charted, the vertical scale ranges from 0 to 100, while the horizontal scale
represents the time line. The RSI oscillator measures the "internal"
momentum in a stock, against itself.
RSI is used to identify tops and bottoms. The consensus is that when the
trendline approaches the 70 to 80 level, the stock is in an overbought
condition. Conversely, when the trendline approaches the 20 to 30 mark, it
is considered oversold. Normally, when a security is in the overbought
range, one should avoid buying new long positions. Conversely, when a stock
is in an oversold condition, one should avoid purchasing new short
positions. Technically, you should follow and trade with a trend, until the
trend reverses and a new signal is generated. These are guidelines, not
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RSI is a confirming trendline that also produces buy and sell signals.
The RSI oscillator needs to be analyzed with other statistics, such as
moving averages and the actual stock price. It’s useful in confirming other
trends, as well as generating its own buy and sell signals. Using a
declining and then rebounding stock as an example, presume that a stock
declines and its RSI reading drops into the 20 to 30 range. As the stock
price subsequently rebounds and the RSI approaches the 50 level, it
indicates a buying opportunity and generates a buy signal. A good example of
a RSI buy signal is reflected in the LSI Logic Diagram above, from February
2003 to September 2003. For those who never heard of LSI Logic, it’s a
midsize semiconductor and storage company with excellent prospects.
RSI identifies divergencies. RSI is also used to identify divergencies of
the actual stock prices or moving averages versus the RSI, which would
signal an upcoming reversal.
RSI verifies trends, chart patterns, support and resistance levels. RSI
is used to verify the upward or downward direction of a stock’s trend. RSI
also helps in identifying a company’s support and resistance levels, as well
as when a company breaks through those levels (breakouts and penetrations).
Additionally, RSI forms chart patterns that are then analyzed.
RSI uses short time periods. In terms of the time period used, most
traders use the 7, 9 and 14 day periods, as well as 21 or 25-day periods.
Each trader has his or her own strategy. The shorter the time period, the
more volatile the index. Big swings in stock prices can distort the results
and give misleading trading signals.
The RSI formula is as follows:
RSI = 100 – [100 / (1 + RS)]
RS = (A/B)
A = Average of N-days that closed up
B = Average of N-Days that closed down
N= Number of days in the period
The theory is that the RSI will identify the top or bottom of a
stock trend, then start the reversal process, before the actual stock prices
reverse their trend. Thus, RSI has some of the characteristics of leading
indicators. It is also used to identify divergencies among other indicators
and prices, as well as to earmark stocks that are oversold or overbought.
Additionally, it can agree with other indicators on a stock’s resistance and
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