This is a Guest Post Submitted by Mr Ankit Jaiswal – Knowledge Associate at Elearnmarkets.com
Trading Strategies using RSI Indicator
Relative Strength Index (RSI) is a momentum oscillator, developed by J. Welles Wilder, which measures the speed and velocity of price movement of trading instruments (stocks, commodity futures, bonds, forex etc.) over a specified period of time. The objective of RSI indicator is to measure the change in price momentum. It is a leading indicator and is widely used by Technical Analyst over the globe.
RSI can be used to spot a general trend. It is considered overbought when it goes above 70 and oversold when it goes below 30. Moreover, RSI can also be used to look for failure swings, divergences and centerline crossover.
The formula for calculating RSI is as follows
RSI = 100 – 100 / (1 + RS)
RS = Average Gain over specified period/ Average loss over the same period
The default setting for RSI is 14, but you may change this value to decrease or increase sensitivity based on your requirement. For instance, 12-day RSI is more likely to reach overbought or oversold levels than 24-day RSI.
Range shift in RSI
Another very important discussion in RSI is “Range Shift” which states whether the market is in bullish or bearish mode.
When the stock in a bullish phase, it oscillates in the range of 40 to 80. On the other hand, when a stock is in a bear phase then it oscillates in the range of 20 to 60. It is seen that whenever there is a change in trend, RSI will undergo a “range shift”.
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Trading strategies using RSI indicator
A buy signal is generated if 5 EMA is cutting 20 EMA and giving a positive crossover. Similarly, 5 EMA should also cut 50 SMA and give a positive crossover. Moreover, RSI should cut 60 level from below.
A sell signal is generated if 5, 20 EMA and 5, 50 EMA gives a negative crossover. RSI should also cut 40 levels from above.
Let’s take an example to understand this. The below is the chart of Tamil Nadu And Paper Ltd. (TNPL). As we can see that when RSI cut the 40 level from above and simultaneously both 5-20 EMA and 5-50 EMA gave a negative crossover, this was the perfect setup for taking a short position. The stock corrected more than 10% after the sell signal.
Similarly, in the next stance as indicated in the chart, we can see that when RSI went above 60, and there was also positive crossover in both 5-20 EMA and 5-50 EMA, which gave a good buy signal. The stock rose around 15% after the buy signal was generated, though it could not sustain at the top. Hence, it is always advisable to keep trailing your stop-loss which you may do using Supertrend.
A buy signal is generated when RSI cuts 30 level from below and the first dot of Parabolic SAR comes below the price.
A sell signal is generated when RSI cuts 70 level from above and the first dot of Parabolic SAR comes above the price.
Let’s take another example to understand the above strategy. The chart below is of GVK Power and Infra and as you can see in the chart that when the first dot of Parabolic SAR appeared below the price and simultaneously RSI also 30 level from below, a buy signal was generated. After the signal, the stock gave a very rapid move on the upside.
Similarly, when the first dot of Parabolic SAR appeared above the price and simultaneously RSI also 70 level from above, sell signal was generated.
RSI is a versatile indicator using which we may find overbought-oversold levels, positive and negative divergences, failure swings, etc. In general, RSI overbought conditions signals ripe for a reversal, but overbought can also be a sign of strength and vice-versa. So it’s not that you should stick to the theory taught, rather you may change it according to your need, to suit your trading style.
However, just like other indicators, the signal quality will also depend upon the characteristics of an underlying security. RSI should also be used in conjunction with other indicators and technical parameters to generate better and more confirmed trading signals.
Moreover, those traders who are unable to devote much time in analysing charts of various securities may benefit from scan section in the StockEdge mobile app. It provides an easier way to track certain trade various opportunities based on RSI indicator. The app also provides an opportunity to club RSI strategy with other indicators, volume, and price patterns base strategies on EOD basis to develop more confirmed signals.
Mr Ankit Jaiswal – Knowledge Associate at Elearnmarkets.com. A commerce graduate from St. Xavier’s College, Kolkata. He strongly believes in the following saying by WarrenBuffett- “Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it”