RSI Indicator: Buy and Sell Signals (2024)

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 orovervalued. A reading of 50 denotes a neutral level or balance between bullish and bearish positions.

The relative strength index (RSI) was introduced in 1978 by technical analyst J. Welles Wilder Jr. in his bookNew 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's an expectation that the market will see a correction in the price in the near term. Overbought assets are generally considered suitable for sale.

The definition of oversold depends, though, 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 lower than their perceived worth. Technical analysts believe oversold assets are those that reach a certain level on a technical indicator, focusing on price and historical data rather than the asset's value.

When it comes to market analysis and trading signals, the RSI is viewed as a bullish indicator when it moves above the horizontal 30 reference level.

Conversely, an RSI that dips below the horizontal 70 reference level is viewed as a bearish indicator. Since some assets are more volatile and move quicker 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 that move in the opposite direction from a technical indicator. Divergence can be either positive or negative, where positive ones indicate that an asset's price hits a new low as the indicator's value climbs. Negative ones, on the other hand, take place when the price hits a new high point while the indicator hits a new low.

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

The divergence between the way an asset's price moves and the RSI oscillator may point to 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 Swings

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

There are two types of failure swings:

• Failure Swing Top: This type of failure swing occurs when the asset's price reaches a high point but the relative strength index drops below the most recent fail 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 point but the RSI jumps above the fail point or the most recent swing high. This indicates a signal to buy the asset.

Failure swings 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 in order to spot the signs of trend reversals.

RSI Ranges

The RSI tends to remain more static during uptrends than it does during downtrends. This makes sense because the RSI measures gains versus losses. In an uptrend, there aremore 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 frequently hit 70. During a downtrend, it is rare to see the RSI exceed 70, and the indicator frequently hits 30 or drops under this threshold. These guidelines can help determine trend strength and spot potential reversals.

For example, if the RSI isn't able to reach 70 on a number of consecutive price swings during an uptrend, but then drops below 30, the trend has weakened and could be reversing lower.

The reverse is true for a downtrend. This means that if the downtrend is unable to reach 30 or below and then rallies above 70, that downtrend is said to weaken. As such, it could end up reversing to the upside.

RSI Trendline Breaks

Momentum Indicators: RSI vs. MACD

Like RSI,the moving average convergence divergence(MACD) is atrend-following momentumindicator that shows the relationship between twomoving averagesof a security’s price. The MACD is calculated by subtracting the 26-periodexponential 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 may 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