Indicators are very well known within the trading community. Indicators though lagging act as great confirmation signals. In this article, we’re going to understand what does RSI mean, what are possible RSI Indicator Strategies and how you can use these strategies to enter a profitable trade.
In this article, we’re not going to dive deep into the definition of RSI, how it is calculated and other formulas. We’re going to jump right into a quick introduction and then discuss how you can implement RSI Indicator in your intraday trading.
Table of Contents
What does RSI mean?
In order to understand what role RSI plays and how you can effectively use RSI in your strategy, remember that RSI (Relative Strength Index) is a direction (momentum) indicator. Also, it is important to know that it oscillates from 0 to 100. We’ll understand what these levels mean later in the article.
Through direction, you could easily identify the current trend of the instrument you’re trading.
For example, let’s say you are all set up to trade AAPL (Apple Inc.) on a 15-minute timeframe. You analyse the support and resistance area levels and figure that the price action has given a positive bullish breakout (via price action). However, what if this is a false breakout or if the market is going to go sideways? You could be easily trapped if you try to go long.
Well, RSI can help you figure that out. With the RSI Indicator Strategies, you could not only identify if the stock can possibly go in a range or not but figuring out if the stock is already in the overbought/ oversold zone and if any further upward movement of the stock is possible or not.
Setting up the indicator
To implement RSI, you can go to the indictors section of the platform you’re using to view the chart and type RSI to active the indicator.
We’re going to change the RSI settings in our case. Click on the settings wheel icon and set the length to 5. We’re changing the length as we want the indicator to react faster to the changes in the price action.
Know when the market in Range Bound
By default a rectangular area (between 70 and 30 RSI levels) is highlighted for you. If it isn’t, just understand that whenever the signal line hovers in between these two RSI levels then it means that the market has gone sideways.
Above chart is of Tesla – 30 minute timeframe. You can see that there isn’t much of a change in the price of the stock for a considerable period of time. The only noticable difference is when the RSI signal line breaks down near the end, and when the signal crosses the 70 mark at the end.
Thus, as long as the Relative Strength Index of the stock doesn’t break the 30 and 70 levels we can say that the market is choppy or range bound.
Breakout or Breakdown confirmation
You may have partially got the idea of how to confirm a good breakdown/breakout. Notice that in the chart above, we can see a breakdown (in the RSI section) near the end. However, the price didn’t go down instantly. Why? That is because the price action was at a strong support level and hence it quickly bounced back.
However, at the end, you can see the indicator gave an early breakout, indicating that the momentum of the stock is strong and in upward direction (bullish).
Needless to say, support and resistance play a very important role in deciding the movement of the price action. Hence you should consider trying out an indicator if you want to confirm your analysis.
Overbought and Oversold Zones
Knowing about the overbought and oversold zones can be a great trading opportunity for you. However, in order to accurately identify these zones, you should set up another RSI indicator with default settings.
Let’s see how.
In the above image (AAPL – 1 hour), we can see that whenever the RSI signal line crosses the 80 mark, then the stock price either goes downwards or sideways. This is known as the overbought zone and it is assumed that when the signal line enters the overbought zone, the price action halts for a moment or breaks down.
Similarly, if the signal line crosses below the 20 mark, it is assumed that the stock price is now in the oversold zone and correction of the price is due.
It is important to note that this situation will not arise frequently. However, it is important to not miss this opportunity when it arises as this strategy works almost always.
We hope you like these RSI indicator strategies and have learnt something valuable through this article. Do follow us on Twitter to stay updated.