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The RSI is one of the most commonly used technical indicators in trading and traders can use a simple formula to generate RSI values.
In many cases, charting tools offer the RSI free of charge and traders can plot the indicator below the price chart to automatically generate signals and implement them in their trading strategies.
RSI Calculation
To calculate the RSI, traders can refer to the formula below:
where RS (Relative Strength) is the average of N days' up closes divided by the average of N days' down closes.
The default period for RSI is often set to 14 days, but traders can adjust this value based on their preferences and the specific market conditions they are analyzing.
The RSI provides a numerical value that ranges from 0 to 100. Traditionally, an RSI reading above 70 is considered overbought, suggesting that the price may have risen too far and could be due for a correction.
Conversely, an RSI reading below 30 is considered oversold, indicating that the price may have fallen too much and could be due for a rebound.
Indicators To Use With The RSI
Relying only on one indicator is not advised when trading, as any indicators, including the RSI, can be prone to generating false signals, leading to unnecessary losses.
Some of the most commonly used indicators alongside the RSI include:
- Moving Averages - Moving averages are trend-following indicators that smooth out price data by creating a single flowing line. The interaction between the price and moving averages can help identify trends and potential reversal points. Crossovers between the price and moving averages, as well as the relative positioning of the RSI to a moving average, can provide additional signals
- Bollinger Bands - Bollinger Bands consist of a middle band being an N-period simple moving average, an upper band at K times an N-period standard deviation above the middle band, and a lower band at K times an N-period standard deviation below the middle band. The bands expand and contract based on volatility
- MACD - MACD is a trend-following momentum indicator that shows the relationship between two moving averages of an asset's price. It consists of a MACD line and a signal line and traders look for crossovers between the MACD line and the signal line, as well as divergences between the MACD and the price, to identify potential trend changes or confirm existing trends
RSI Example - Apple Stock
To better understand how the RSI works in practice, we can look at the indicator plotted below the price chart of Apple to see what values the indicator generates and at what price points:
As evident on the chart, when the RSI spikes, traders may interpret this as an overbought sign and sell the stock.
Conversely, when the RSI shows a low value, traders buy more in the hopes of the price increasing in the short term.
However, relying only on the RSI is not advisable, as it is a leading indicator and provides early signs, which can be unreliable at times.
