The usage of RSI is one of the most misunderstood indicators in the Market, that not many people understand. So, how do you actually use it? Watch our engaging and easy-to-understand video from the #LearnWithUpstox series to get a clear understanding of the Relative Strength Index.
Welcome back to a new blog of ‘Learn with Upstox’. This blog is about the world's most misunderstood Indicator. Relative Strength index (RSI) is an Indicator that almost everyone uses. So most of us would have heard the terms ‘Overbought’ and ‘Oversold’. RSI indicates when the stock price moves into overbought and oversold zones.
Let's start with the Relative Strength Index or RSI, the three words that make this indicator. What is the middle word? Strength! It is a momentum indicator which is the key strength of the price. RSI is therefore, directly proportional to the price, which means if the RSI increases, so does the price, and if the RSI decreases, so does the price. But this is completely opposite to overbought and oversold, and this is where the confusion lies, making it the misunderstood indicator.
If you type in the indicators – RSI, three or four types will appear. RSI, RSI Strategy, Connors RSI and more. Click on RSI. Refer to the chart below to see how it should look. Do not change any inputs in the settings. For Intraday traders, the correct settings should be 60 for upper band and 40 for lower band. You will notice that the pink band appears between scale 60 and 40. For Swing traders, use 70 and 30.
So, RSI oscillates between 0 – 100. At 50, RSI is neutral, above 50 it is bullish and below 50, it is bearish. If it rises above 50, it means momentum is increasing, which should mean that price should also increase and vice versa. So, one needs to buy above the pink band, that is above 60/70, while they should sell below the band, that is below 40/30.
To understand how to use RSI, refer to the charts given below. You will see that I have drawn support lines around our price candles. Remember to check that RSI and price are going in the same direction always. So, not only should our RSI be breaking below the pink band, but our support should also be broken by the price. You will notice in the chart below, that though the RSI breaks the pink band below 40 a couple of times, our price stays above the support line, making it stable. But at the last point, when RSI breaks the 40 lower band, so does the price, making it the perfect space to short sell. Always wait for a double confirmation.
Look at the chart below for an example of buy stock. You will notice that RSI doesn’t cross 60 band, but the price has broken through resistance, so do not initiate buy here. But the second time RSI breaks the upper band and price also breaks through resistance, which makes it a perfect space to place a buy, as the momentum is high.
So, this is how both price and RSI work in conjunction. The overbought and oversold zones are used for long-term investments from weekly onwards. Look at the chart below. This is a weeklong chart and RSI band is placed at 70 and 30. Here wherever the RSI breaks 70, we say it is in the overbought zone. When it comes below 30, it is oversold. Whenever something is overbought, it means it has gone through most of the logical profits, and hence, it needs to be sold. Similarly, when RSI is in the oversold zone, it has hit its low and will rise, so it is a good buy. This is because the market has already been stretched, and price always moves in a zigzag pattern.
So, in shorter time frames, use RSI to know the strength of the price movement. Do not get confused. Use it as per time frames. If you have any questions, leave them in the comments below.