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Charts courtesy of stockcharts.com

Sunday, February 22, 2009

RSI

I'm not a big fan of technical indicators. Although they can, if used properly, impart a lot of useful information, their "proper" usage is very subjective, and can change with conditions. However, by carefully looking at the indicators, and understanding what they are saying, you can gain an edge in your trading, which often is the difference between a gain and a loss.

Relative Strength Index (RSI) is one of the momentum indicators and is very popular, and in fact is one of the default indicators when using stockcharts.com's free charts. It is not related to the "relative strength" that IBD uses in their daily charts, and that is often the cause of confusion. RSI " compares the magnitude of a stock's recent gains to the magnitude of its recent losses and turns that information into a number that ranges from 0 to 100." The time period can be any time period, but the default is 14. Stockcharts' chart school article goes into great detail about how RSI is calculated, but it really isn't necessary to know to use it.


There are several signals that RSI can give. Depending on the time frame you are using, they can be short, intermediate, or longer term signals. When RSI gets above 70, the chart is considered overbought. When it breaks downward through 70, that is considered a sell signal. Going below 30 is considered oversold, and when it crosses back above 30 that is considered a buy signal. The centerline, at 50, is also often used to signal confirmations of signals given by other indicators. For instance, if MACD gives a bullish signal, a trader might wait to see if RSI crosses 50 from below before acting upon it, likewise crosses of 50 from above confirm bearish signals.


Here is RSI with a time period of 30. Notice that it significantly smooths out the line, and also gives fewer signals. This would cut down on whipsaws, but would miss short term trends, instead looking for longer term trends.



By contrast, an RSI of 2 would give constant signals. This is where RSI seems most useful, as it can catch very short term oversold and overbought conditions which a nimble day trader can exploit.

In summary, RSI determines the momentum, or strength of movement, of a trend, which is detemined by other indicators. As such, RSI is not very useful by itself, but is very useful when combined with a trend indicator.

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