Trend Trading: The 4 Most Common Indicators ( Relative Strength Index (RSI) ) (part3)

Trend Trading: The 4 Most Common Indicators ( Relative Strength Index (RSI) ) (part3)

Relative Strength Index (RSI)

The relative strength index (RSI) is another oscillating indicator but its movement is contained between zero and 100 so it provides different information than the MACD.
One way to interpret the RSI is by viewing the price as "overbought"—and due for a correction—when the indicator in the histogram is above 70, and viewing the price as oversold—and due for a bounce—when the indicator is below 30.3
In a strong uptrend, the price will often reach 70 and beyond for sustained periods of time. For downtrends, the price can stay at 30 or below for a long time. While general overbought and oversold levels can be accurate occasionally, they may not provide the most timely signals for trend traders.3
An alternative is to buy close to oversold conditions when the trend is up and place a short trade near an overbought condition in a downtrend.
For example, suppose the long-term trend of a stock is up. A buy signal occurs when the RSI moves below 50 and then back above it. Essentially, this means a pullback in price has occurred. So the trader buys once the pullback appears to have ended (according to the RSI) and the trend is resuming. The 50-levels are used because the RSI doesn't typically reach 30 in an uptrend unless a potential reversal is underway. A short-trade signal occurs when the trend is down and the RSI moves above 50 and then back below it.3
Trendlines or a moving average can help establish the trend direction and in which direction to take trade signals.