RSI Indicator: Buy and Sell Signals

The Relative Strength Index (RSI) is a momentum indicator that measures recent price changes as it moves between 0 and 100. The RSI provides short-term buy and sell signals and is used to track the overbought and oversold levels of an asset.

Low RSI levels, below 30, generate buy signals and indicate an oversold or undervalued condition. High RSI levels, above 70, generate sell signals and suggest that a security is overbought or overvalued. A reading of 50 indicates a neutral level or balance between bullish and bearish positions.

The relative strength index (RSI) was developed in 1978 by technical analyst J. Welles Wilder Jr. introduced in his book New Concepts in Technical Trading Systems.

Overbought and oversold levels

The term overbought refers to an instance when an asset’s trading value is above its fair or intrinsic value. An overbought asset tends to be indicative of recent or short-term price movements. As such, there is an expectation that the market will see a correction in the price in the near term. Overbought assets are generally considered available for sale.

However, the definition of oversold depends on who you ask. Fundamental traders believe that an asset is oversold when its price is lower than its fair or intrinsic value. Therefore, they trade below their perceived value. Technical analysts believe oversold assets are those that reach a certain level on a technical indicator, and focus on price and historical data rather than the asset’s value.

In terms of market analysis and trading signals, the RSI is considered a bullish indicator when it moves above the horizontal 30 reference level.

Conversely, an RSI that falls below the horizontal 70 reference level is considered a bearish indicator. Since some assets are more volatile and move faster than others, the values ​​of 80 and 20 are also frequently used levels for overbought and oversold assets.

Divergence in price and RSI Oscillator

Divergence is a term used by technical analysts to describe signals of prices moving in the opposite direction of a technical indicator. Divergence can be either positive or negative, where positives indicate that an asset’s price is reaching a new low as the indicator’s value climbs. Negatives, on the other hand, occur when the price reaches a new high while the indicator reaches a new low.

In technical analysis, oscillators are used to make high and low banks that exist between two different extremes. These are momentum indicators that can be used in conjunction with other indicators to spot corrections and price breakouts. This tool then forms a trend indicator, which rises and falls within these extreme values.

The difference between the way an asset’s price moves and the RSI oscillator can indicate the possibility of a reversal in trends. So when the asset’s price reaches a higher high and the RSI reaches a lower high, the trader can recognize a bearish divergence. A bullish divergence occurs in the opposite scenario.

Failure swing

Trend signals that indicate a reversal are called failure swings. These swings can occur during uptrends and downtrends, where the former indicates selling activity while the latter represents buying activity. Failures occur when the index oscillator does not follow the high in an uptrend or a low in the downtrend.

There are two types of failures:

Failure Swing Top: This type of failure swing occurs when the asset’s price reaches a high, but the relative strength index falls below the most recent failure point (the recent swing low). When this happens, it indicates a signal to sell the asset. Failure Swing Bottom: The failure swing bottom occurs when the asset’s price hits the low, but the RSI jumps above the failure point or the most recent swing high. This indicates a signal to buy the asset.

Failures can be very useful for investors who know how to use them. As such, they can be used to trade RSI divergences by identifying recent trends to spot the signs of trend reversals.

RSI ranges

The RSI tends to remain more static during uptrends than during downtrends. This makes sense because the RSI measures gains versus losses. In an uptrend, there are more gains, keeping the RSI at higher levels. In a downtrend, on the other hand, the RSI tends to stay at lower levels.

During an uptrend, the RSI tends to stay above 30 and should reach 70 frequently. During a downtrend, it is rare to see the RSI exceed 70, and the indicator frequently hits 30 or drops below this threshold. These guidelines can help determine trend strength and spot potential reversals.

For example, if the RSI is unable to reach 70 on a number of consecutive price swings during an uptrend, but then falls below 30, the trend has weakened and may reverse lower.

The reverse is true for a downtrend. This means that if the downtrend fails to reach 30 or less and then rises above 70, that downtrend is said to be weakening. As such, it may eventually reverse upwards.

RSI Trendline Breaks

Momentum Indicators: RSI vs MACD

Like RSI, the moving average convergence divergence (MACD) is a trend-following momentum indicator that shows the relationship between two moving averages of a security’s price. The MACD is calculated by subtracting the 26-period exponential moving average (EMA) from the 12-period EMA. The result of that calculation is the MACD line.

A nine-day EMA of the MACD called the “signal line” is then plotted on top of the MACD line, which can function as a trigger for buy and sell signals. Traders can buy the security when the MACD crosses above its signal line and sell or short the security when the MACD crosses below the signal line.

Frequently Asked Questions