RSI or Relative Strength Index is quite a familiar term in technical analysis. Every investor must come across RSI indicator in order to identify the market strength and trend. The name Relative Strength Index itself defines its meaning. The concept was developed by J. Welles Widder, belongs to momentum oscillator category, shows the rate of the rise or fall in price. The article is about beginner’s guide to RSI trading. By following this indicator, an investor can recognize these following situations:
- Overbought situation
- Oversold situation
- Bearish trend
- Bullish trend
- Bearish Divergence
- Bullish Divergence
What is RSI Trading
As I have mentioned that RSI is a momentum oscillator which oscillates between zero and hundred. A reading above 70 is considered overbought and below 30 oversold. The application of the indicator mainly works in cash and future market. Generally, investors work with the indicator based on the mid-level 50. The mid-line helps to spot the bullish and bearish trend.
In order to simplify the calculation process, it has been broken into this simple formula.
RSI = 100 – 100 / (1 + RS) Here RS means (Average of Upward Price Change / Average of Downward Price Change). The default time frame should be in 14 (for comparing up periods to down periods is 14).
RSI Trading Example
Let’s go for an example of RSI indicator with an image so that I can clarify the subject more easily.
The above chart is attached with RSI indicator. As you can see from zero level to hundred RSI oscillates. The yellow mid-line is standing at 50. Above 50 is the bullish zone while below 50 considers bearish zone. Here we can identify the overbought level easily (above 70 level) but in this chart, there is no oversold level, breakout happens at the level 30 twice, after the breakout the trend reverse.
There is another well-known pattern you can notice by applying RSI, that is divergence pattern. Previously I have written an article based on the bullish divergence pattern with an example of Glenmark Pharma. When the price action makes a lower low and RSI establishes higher low, bullish divergence pattern form by the disagreement between price action and RSI. In case of bearish divergence, the price action completes higher high while the indicator makes a lower high.
Besides this, there is the swing breakout which one can identify with RSI indicator. RSI developer Welles Wilder considered the failure of swings is a very strong signal for the market trend reversal.
Therefore, these are some of the most important points regarding RSI trading for beginners. For identifying market trend and strength, you can take the support of the specific indicator.
Categories: Trading Strategy