Introduction to RSI indicator

Indicator based trading is one the most popular ways to analyze the markets in technical analysis. Out of the many indicators, the RSI indicator is an extensively used indicator by all sets of traders. Thus, it becomes necessary for traders to have a fair understanding of the basics and the working of the indicator. Without any further ado, let’s get right into the fundamentals of the RSI indicator. 

What is RSI?

Firstly, RSI stands for Relative Strength Index. It is a technical analysis indicator that depicts oversold and overbought conditions in the market. And since it oscillates between two levels, it is classified as an oscillator indicator. However, the RSI is different from other oscillators. As the name suggests, the RSI also helps in gauging the momentum of the market. In other terms, it measures the speed/velocity of the price movements in a security. Thus, RSI can be considered as a momentum indicator as well. And the combination of the oscillator with momentum is what makes RSI a real charming indicator.

What does the RSI indicator look like?

The RSI is not an on-chart indicator, like the moving average. As mentioned, it essentially is an oscillator and moves within two fixed levels (0 and 100). 

Below is the price chart of Apple Inc., with the RSI indicator, plotted for it. We can see that the line has been oscillating with the 0-100 mark.

Overbought and Oversold levels

In the above RSI indicator, the level between 30 and 70 is given a purple shade. This region indicates that the market is under normal condition. If the line breaches through the 70 marks, the market is said to be overbought. Conversely, if a line breaks below the 30 level, the market is considered to be in an oversold state.

Significance and Importance of Overbought and Oversold Levels

The true value of RSI lies in the overbought and oversold levels.

The line going above 70 indicates that a security is bought more than the expected average. As a result, profit-taking by the buyers could cause a drop in the prices.

On the other hand, the line going below the 30 level indicates that the security is sold extremely. And following it, we can expect some short covering, leading to some bullishness in the market.

Typically, as a trader, we look for 

Buying opportunities when the market is in the oversold region

Selling opportunities when the market is in the overbought region

What are RSI alerts?

Alerts notify a user when the indicator moves past a critical price level. RSI alerts are the type of alerts that notify you when the price enters or leaves the overbought or oversold regions. Essentially, the user receives a notification (on the phone) when the RSI line touches the 30 level or 70 level on the indicator.

How to use RSI alerts?

Most traders apply the RSI indicator on their charts, primarily to determine oversold and overbought levels in the market. If looked closely, these levels give us a fair idea on where the market could head towards based in the future. In simple terms, overbought and oversold areas act as a buy/sell signal provider. Thus, always keeping an eye on these levels is important.

There are several securities in the stock market. It is practically impossible to analyze every stock and determine if the price is overbought or oversold. In fact, it is tiring and time-consuming to analyze even 20 stocks a day. And here is where the use of RSI alerts comes in.

RSI alerts notify traders of the overbought and oversold regions for multiple stocks. This hence saves a significant amount of time for trades, as the alerts filter out the required stocks.

Thus, traders can simply enable RSI alerts and use it as a confirmatory tool or as a buy/sell signal provider using oversold or overbought levels. Following are a couple of trading strategies that could give you a clear understanding of how the RSI indicator can be used.

RSI Trading Strategies

The RSI indicator can be traded in several ways. The best of this indicator is that it can be combined with any other type of analysis.

RSI Trend Continuation Strategy – Sell Example

This strategy is used to anticipate the overall trend of the market using RSI overbought/oversold levels.

In the below chart of Amazon.com Inc., the overall trend of the market is down. Since the price is in a downtrend, we must look for short-selling opportunities. 

During the retracement, the price tested all the way up to the Resistance at 1853.16. At the same time, the RSI line was in the overbought region as indicated. Here, the overall trend, Resistance level, as well as the RSI, is signalling.

Aggressive traders may enter right when they are notified by the RSI alert for the line falling inside the 70 mark, while conservative traders must enter when the price retests the Resistance level as shown.

Trade Management

Stop Loss

The stops can be placed above the supply shown on the chart.

Take Profit

The ideal take profit for trend continuation trades would be at the recent low. If the momentum of the sellers is coming along strong, the take profit can be adjusted accordingly.

RSI Trend Reversal Strategy – Buy Example

The overbought/oversold on the RSI can be used to speculate the occurrence of a market reversal.

Consider the chart of Tesla Inc. shown below. In the beginning, the market was in a downtrend, making lower highs and lower lows.

On 16 March, we would’ve received an alert saying that the price is oversold. And this is when we put our focus into analyzing Tesla.

Lower lows and lower highs indicate that the sellers are in control of the market. Later, a couple of price actions indicated signs of a reversal:

🡪 RSI line passed above the 30 mark.

🡪 lower low turned into a higher low

Both these points signify that the buyers are trying to take control of the market. Thus, we can enter around the levels where the price made a higher low. 

Trade Management

Stop Loss

Can be placed right below the lower high.

Take Profit

The area where the selling originated from.

Conclusion

There are hundreds of indicators in the industry. And the RSI never fails to top the list, for the benefits it has to offer. Precisely speaking, oversold and overbought are the levels that give traders an edge in their trading.  

With the existence of several securities, it becomes tiring to keep a watch on all of them. The solution to the problem can be achieved with the help of RSI alerts. RSI alerts act like a stock selector which notify you with only stocks that are oversold or overbought. Hence, these alerts can come handy if you don’t stay on the screen all day long.