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Use of RSI in Early Identification of Trend Reversal

WHAT IS RSI

Relative Strength Index is a momentum oscillator, used in the identification of trend reversal. RSI can analyze the strength of trend and thereby predict the reversals. Generally, the average lookback period for RSI is 14. In order to increase or decrease sensitivity, this value is often lowered or raised.

RSI LEVELS

RSI is also called ‘Limiting Oscillator’. This is because it oscillates within a limit of 0 and 100. A security becomes overbought when the RSI value is above 70. Similarly, a security becomes oversold when the indicator value is below 30. However, some traders use 75,25 or 80,20 values for overbought and oversold levels.

Normally in a bullish market or uptrend, it tends to persist in 40-90 range with 40 to 60 zones as support. Likewise, in a bearish market or downtrend, it tends to remain within 10-60 with 50 to 60 zones as resistance.

DIVERGENCE

When the directional momentum does not certify the price, divergence indicates a  potential reversal point. A positive divergence is when the indicator shows higher highs and lows, while the price makes lower highs and lows. Conversely, a negative divergence is when the indicator shows lower highs and lows, while the price makes higher lows and highs. Yet, divergence does not have much importance in sideways market.

BEST USES

  • Helps in covering profits by analyzing overbought stocks.
  • Can identify oversold as well as potential reversal stocks.
  • Used in identifying the direction of trend. Stocks above 50 are uptrend and below 50 are downtrend.

TRADING STRATEGIES WITH RSI

  • During a positive divergence, a dependable sell signal generates.
  • During a negative divergence, a dependable buy signal generates.
  • When RSI crosses the centre line from below, it indicates a stronger trend change has happened and it is obvious to go long.
  • When it crosses from above, it indicates that the average losses are overtaking the average gains and it shows a fresh profit booking or short selling.

DEVELOPED TRADING STRATEGIES

  • Sell : Here, RSI goes below 50 along with the blend of EMA(8) and EMA(21). Also, the prices trade below EMA(50).
  • Buy : Here, it goes above 50 along with the blend of EMA(8) and EMA(21). Also, the prices trade above EMA(50).
  • Profit Booking : During the Bullish crossover of EMA(8) and EMA(21) or when the price candle closes above EMA(8).

CONCLUSION

RSI is one of the crucial indicators of technical analysis. It is still a very useful indicator in the identification of trend reversals. Along with other indicators, RSI can be a very successful trading strategy.

 

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