What Does RSI Mean In Trading?

What Does RSI Mean In Trading?

Trading is a highly technical process that involves collecting and analyzing data from a variety of sources, with the price chart being one of the most important such sources. 

If you have some experience trading forex, stocks, or crypto, you may have come across an abbreviation called ‘RSI’. 

RSI is an abbreviation for the Relative Strength Index, which is a popular technical indicator used in trading that measures the speed and change of price movements in financial markets.

RSI is a momentum oscillator that is useful in generating overbought and oversold signals on a price chart, which gives traders a better idea of when to enter and exit the market. 

Understanding the signals generated by the RSI can help traders and analysts assess the likelihood of a potential reversal in the price trend.

RSI is typically used in conjunction with other technical indicators to avoid false signals, which we will discuss further in the coming sections. 

If you are a beginner trader and would like to know more about the RSI and what it shows, this Investfox guide is for you. 

How The RSI Works In Trading

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:

rsi formula.png

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:

apple rsi.png

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. 

Key Takeaways From What Does RSI Mean In Trading

  • RSI, or the Relative Strength Index, is a commonly used indicator that shows the speed of price change of an asset
  • The RSI generates overbought and oversold signals on a scale of 1 to 100
  • Traders typically use the RSI in conjunction with other technical indicators, such as the MACD, Bollinger Bands, and moving averages
  • A RSI value of 30 or less implies oversold, while a value of 70 or more indicates an overbought condition 

FAQ On RSI In Trading

How does the RSI work in trading?

The Relative Strength Index (RSI) measures the speed and change of price movements in a financial market. It oscillates between 0 and 100, identifying overbought conditions (above 70) and oversold conditions (below 30), aiding traders in assessing potential trend reversals.

Is the RSI a reliable indicator?

The RSI can be a reliable indicator when used in conjunction with other tools for market analysis. It helps identify overbought and oversold conditions, providing valuable insights, but it's essential to consider broader market context and use multiple indicators for confirmation.

When should I use the RSI?

Use the RSI to identify potential overbought or oversold conditions in a market. Consider using it in conjunction with other technical indicators and analyze trends to confirm signals. It's most effective when applied within a comprehensive trading strategy.