RSI Indicator – Part III

Articles From: QuantInsti
Website: QuantInsti



Get up-to-speed with RSI Indicator with the tutorial in Part II.

RSI Strategies

RSI as a trend indicator

RSI works as a reference when you want to gauge if the market is going through a bullish or bearish trend. While the general assumption that an indicator above 70 indicates overbought and below 30 indicates oversold holds true for most of the cases, there are others who insist that it can be held true for values above 66.6 and below 33.3 as well.

If the RSI closes above 66.6 but goes below the value, it should not be assumed that the trend has reversed and you should short the stock immediately. Instead, we look for the graph and as long as it stays above 33.3, we can say that the market is still bullish when it comes to the asset.

You can see in the graph below that the RSI indicator crossed the overbought zone in July 2018 and since then, the price continued to rise indicating a bull run.

RSI Trend Indicator

Similarly, if the RSI goes below 33.3 and rises up but doesn’t cross the 66.6 barriers (or 70, as is assumed), we can conclude that the market is bearish.

However, one should not take this as a sole indication to buy (or sell) the asset in question. We will go forward to the next topic to understand the whole picture.

RSI as support and resistance

As we have understood how to set up the RSI trend indicator, we can see that as the number of periods of gains increases when compared to the number of periods of losses, the RSI values will keep increasing. Thus, it gives a strong indication of a longer-term trend than the closing prices where the daily price fluctuations could show us a different story.

Just like the closing prices, we can use the RSI indicator values to draw a trendline of the support and resistance levels and thus, a breakout from this trend can be easily observed in the RSI values a market position taken. You can see in the following graph how both the RSI and closing price have a breakout.

RSI Support and Resistance

The deal here is to correctly identify if the breakout is sustainable for a long period or a false signal.

Stay tuned for the next installment in this series to learn more about RSI and divergence.

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