What is the RSI technical indicator?
The Relative Strength Index (RSI) is one of the most widely used and well-known technical indicators in trading and the stock market, developed by Welles Wilder, and is ideal for doing a good analysis and investing in the stock market. The RSI technical indicator is calculated from a price difference or moving averages within a fixed time interval. The RSI technical indicator gives us an approximation to the speed of the market, if in a bull market, the RSI starts to drop, it tells us that the rise is starting to weaken. It will help us traders to detect reversals in the trend by looking at divergences, and that is why you can trade with the RSI technical indicator.
There are many strategies with the RSI (Relative Strength Index) indicator, depending on the type of asset on the stock market, the characteristics of the trader and his tolerance for risk, one or the other can be applied, the appropriate thing is to test the strategies before, in function of monetary management, volatility and temporary space to see what type of investor we are and in each asset what strategy to follow. Indicators such as the RSI are essential in trading when investing, with which you can carry out a complementary analysis of the market.
Zone Exit Strategy
The RSI indicator is bounded between 0 and 100, therefore two zones can be differentiated, one of overbought, and another of oversold. This is the starting data for a trader to make a correct analysis of the market with indicators such as the RSI. This range can vary generally used between 70 and 100 for overbought and between 0 and 30 for oversold although it depends on the asset, it can be adjusted to more optimal levels.
This RSI trading strategy involves buying when the RSI breaks out of the oversold zone and selling short when it breaks out of the overbought zone. This is the basis of the trading and stock market system with the RSI. The stop would be placed when the RSI technical indicator re-enters the overbought or oversold zone, depending on the trade made, whether it is long or short. Let’s see in the following image a market analysis that any trader could do with the RSI.
In the chart we can see how there is a first bearish signal that would give us a very tight entry to invest, to later give another bearish signal with a longer run. Then we see a bullish signal with a wide range and finally again two bearish signals with a very limited range.
The position is closed when the RSI technical indicator enters the overbought zone (for a bullish trade) and when it enters the oversold zone (for a bearish position). There is not much more, that is how simple the trading and stock market system offered by this indicator is.
Divergence Strategy
The “divergence” strategy in trading with the RSI indicator (Relative Strength Index) combines a “failure swing” with the price evolution. The position will only be opened if the RSI and the price diverge. When we see that the lows of the price and the RSI are diverging, it means that we could approach a trend change from bearish to bullish. On the other hand, when the highs of the price and the RSI (Relative Strength Index) technical indicator diverge, we could find ourselves facing a change in trend from bullish to bearish. It is a widely used strategy in trading.
The explanation of the divergence in trading is due to the fact that the RSI shows a lower value in the second maximum, which means that the average of the sum of the increases with respect to the sum of the increases and decreases is lower than in the previous moment . (second peak lower than the first) which would be giving weakness to the price.
Being the average of the minor increases, it gives us a indication that the price may be weakening plus.
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