How I Use the RSI Indicator

How I Use the RSI Indicator

The RSI (Relative Strength Indicator) is a is a momentum oscillator that measures the speed and change of price movements.  The RSI moves in a bounded range between zero and 100. I use the RSI on the (14) setting on the daily chart. The RSI is generally overbought when its reading is above 70 and oversold when it reads below 30. Signals can also be generated by looking for divergences between RSI and price action as one makes a higher high or lower low and the other doesn’t, parabolic break outs below 30 or above 70 on a closing basis and also centerline crossovers of price. RSI can also be used to identify the current trend of the market as price is generally above the 50 RSI in an uptrend and below the 50 RSI during a downtrend. 

I like to use the RSI as an entry signal looking to buy the best stocks or index ETFs when price is near the 30 RSI reading. I prefer bounces at the 30 RSI to confirm support or breaks under and back over the 30 RSI to confirm it is near a bottom. The 50 RSI is usually a good reward target on a 30 RSI entry. 

When I am long during up trends I look to exit and lock in profits when the 70 RSI starts to become resistance. If price breaks above and closes higher than the 70 RSI I will hold my long position as the potential of a parabolic uptrend increases. 

I look at the RSI chart as an oscillator that measures the risk/reward ratio. As it nears 30 the reward favors the buyer as a stock or index has moved too far down too fast and could be due for a bounce. At the 70 RSI the reward for long positions has started to diminish in most cases as a stock or index becomes overbought after having gone up too far and too fast. It is more probable that a stock can move from a 50 RSI to a 70 RSI than to move from a 70 RSI to a 90 RSI. Not impossible just less likely in the majority of cases. 

A market will spend most of its time inside the 30/70 RSI boundaries and rarely leaves this range. Combining the best stocks that are in demand with 30 RSI dips increases the odds of success as their are buyers wanting in. Parabolic extended trends is what typically breaks the bounds of the RSI. The value zone is the 50 RSI and price tends to return to that area over time. 

The RSI does not work perfectly every time as nothing does so you must still use proper position sizing to manage risk and stop out for a loss when price trends beyond its boundaries, but it is a great tool for quantifying the oversold and overbought parameters for items on your watch list.