RSI Indicator: How to Use It for Trading and Investing Success

The relative Strength Index is used by retail financial traders to gauge market momentum and define how prices change from 0 to 100. The indicator is not new as it was developed back in 1978 by Welles Wilder. Below we will outline the exact guide on how to use RSI in financial trading and how it improves performance.

RSI Indicator Explained

RSI is a momentum oscillator that deviates between 0 and 100 and measures the speed of price changes. RSI measures momentum on a scale of 0-100, making it a powerful addition to the trader’s arsenal. Many traders use RSI to detect overbought and oversold levels and use it as a signal confirmation. When RSI is above 70 it is overbought and when it slides below 30 it is oversold.

RSI Settings

Selecting a proper RSI indicator settings is paramount for successful trading. Scalpers will need RSI with shorter periods while traders who focus on higher timeframes will use longer periods to eliminate noise and reduce false signals.

How RSI is calculated?

Most modern trading platforms incorporate RSI and calculate it automatically according to user-specified settings. Below is the formula for the indicator:

RSI = 100 - (100 / 1 + RS)

RS is the ratio of average gains to average losses over a set period of time (default is 14).

Should You Use RSI?

RSI helps traders better catch trend reversals with overbought and overall conditions. However, the most powerful method is a divergence when the RSI shows higher highs while the prices show lower lows in a bear trend (the opposite is true in a bullish trend). When divergence occurs, it might signal the trend reversal is going to happen soon.

However, many traders do not use RSI as overbought and oversold signals are mostly false and divergences are rare. Despite this, RSI can be a nice addition to your technical analysis and has the potential to increase trading accuracy and detect trend changes early.

Implementing RSI in Trading and Investing

Adding RSI to your chart is super simple. Just open indicators and go to oscillators. Then select RSI and set your preferred parameters to apply, then click OK. all modern trading platforms offer RSI and some of them even provide modified RSI indicators. For example, TradingView offers a Stochastic RSI indicator that combines RSI with another popular indicator, Stochastic oscillator.

How to use RSI in Trading

In day trading, RSI is best used as a confirmation indicator. In no case should traders use RSI as a sole indicator. Buy signals are valid when RSI crosses above 70 and sell signals can be taken when RSI falls below 30. Yes, it is a bad idea to sell when RSI is above 70 and buy when it falls below 30 as string trends do not care about indicators.

Using RSI in Investing

Investors can use RSI as an early signal of trend reversals. Unlike traders, investors can hold certain assets for months and even years. If the stock has been moving in an uptrend and the RSI starts to fall below 30, it might indicate that a price reversal is near. In this case, RSI would be used as an early warning signal to lock in profits from longer-term positions.

The Bottom Line

Relative Strength Index remains a popular and trusted indicator in the trader’s arsenal, even though decades have passed since its creation. While RSI is not a standalone solution it is widely used as a confirmation tool. It can signal trend reversals as it measures momentum. RSI can be used in both day trading and investing. In day trading, RSI is best used as a confirmation tool while in investing it can be used to detect early signs of reversals. Using RSI, traders can make their technical analysis more accurate and make informed trading decisions.