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The relative strength index (RSI) is a momentum indicator used in technical analysis that measures the momentum of price trends to evaluate overbought and oversold situations in the stock price. The Relative strength index is showing an oscillator and can have a reading from 0 to 100 and a default range of 70 to 30.
RSI: THE BACKGROUND
The relative strength index (RSI) was developed by J.Welles Wilder Jr. and introduced in his seminal 1978 book, “New Concept in Technical Trading Systems. Traditional interpretations and usage of the RSI dictate that values of 70 or above become overbought or overvalued conditions and an RSI reading of 30 or below indicates an oversold or undervalued condition.
The RSI is computed with a two-part calculation that starts with the following formula. The RSI can be calculated, where the RSI line can then be plotted beneath a stock price chart. The RSI will rise as the number and size of positive closes increase, and it will fall as the number and size of losses increase. The second part of the calculation smoothes the result, so RSI will only be near 100 or 0 in a strongly trending market.
RSI: CHART INTERPRETATION
When the RSI surpasses the horizontal 30 reference level, it is a bullish sign, and when it slides below the horizontal 70 reference level, it is a bearish sign. Traders use RSI with other technical indicators to identify great opportunities for entering or exit positions.
An RSI value of 70 or above indicates overbought and An RSI value of 30 or below indicates an oversold. During trends, the RSI reading may fall into a band or ring. During an uptrend, the RSI trends to say 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 below.
OVER BOUGHT RSI
Overbought means an instance when stock trading value is above it’s ringed. A stock that is overbought trends to be indicating of recent or short-term price movement. As such, there’s an expectation that the market will see a correction in the price in the near term.
Stocks that are overbought are generally considered suitable for sale.
Oversold means that a stock is oversold when its price is lower than it’s fair. A stock that is oversold trends to be indicating of recent or short-term price movement.
Stocks that are oversold are generally considered suitable for buy.
DIVERGENCE: RSI AND PRICE
Divergence is a term used by technical analysts to describe signals of prices that move in the opposite direction from a technical indicator.
A bullish divergence occurs when the RSI creates an oversold reading followed by a higher low that matches correspondingly lower lows in price. This indicates rising bullish momentum.
A bearish divergence occurs when the RSI creates an overbought reading followed by a lower high that matches correspondingly higher highs in price. This indicates bearish momentum.