The Relative Strength Index (RSI) oscillator is a technical analysis tool used in financial markets, particularly in stock trading, to measure the magnitude and momentum of price changes over a specified period of time.
The RSI oscillator ranges from 0 to 100 and is typically used to identify potential overbought or oversold conditions in a security.
The RSI oscillator is calculated using the following formula: RSI = 100 – [100 / (1 + RS)] where RS is the average of the gains and losses over a specified time period. The RSI is typically displayed as a line graph, with values plotted along the vertical axis from 0 to 100, and time periods plotted along the horizontal axis.
The RSI oscillator is interpreted as follows:
Overbought condition: When the RSI rises above 70, it is generally considered an indication of an overbought condition, which means the security may have experienced a price increase that is not sustainable and could potentially be due for a pullback or correction.
Oversold condition: When the RSI falls below 30, it is generally considered an indication of an oversold condition, which means the security may have experienced a price decrease that is not sustainable and could potentially be due for a rebound or recovery.
Divergence: RSI divergence occurs when the price of a security and its RSI oscillator move in opposite directions. For example, if the price of a stock is making higher highs, but the RSI is making lower highs, it could be a sign of potential weakness in the stock’s price trend.
Here are some examples of how the RSI oscillator can be used:
Buy signal: A trader may consider buying a stock when the RSI falls into oversold territory (e.g., below 30) and then rises above 30, which could indicate a potential rebound or recovery in the stock price.
Sell signal: A trader may consider selling a stock when the RSI rises into overbought territory (e.g., above 70) and then falls below 70, which could indicate a potential pullback or correction in the stock price.
Confirmation signal: If the price of a security is making new highs, and the RSI is also making new highs, it could be seen as a confirmation of a strong uptrend in the security.
It’s important to note that the RSI oscillator is just one tool among many in technical analysis and should be used in conjunction with other technical and fundamental indicators, as well as prudent risk management practices, for making informed trading decisions.