I'm sure you have heard about RSI or the Relative Strength Index before. Most traders use RSI strategies when looking at the market to help spot extreme areas. Above 70 is considered overbought and below 30 is considered oversold. Personally, I think when you hear someone talk about this you should cover your ears and make loud noises until they stop speaking!
What Is The Relative Strength Index RSI?
First you really need to know more about the actual indicator itself. RSI is a momentum indicator or oscillator that measures the speed and change of price movements in a security. Traditionally it will move between 0 and 100. A stock is usually considered overbought when RSI is above 70 and oversold when RSI is below 30.
Trading RSI Divergences
So before I said you should cover your ears when someone says RSI is at an extreme right? Well, this is because it is NOT a great signal just to have RSI at an extreme. You have to see some kind of divergence with RSI and the underlying security to get a valid signal.
RSI does point out divergences between price and momentum and these signals are much more consistent (not perfect) than just simply looking for extremes. As the more advanced traders can tell you, RSI can stay very high or very low and trade with trend strength.
That's why looking for the divergences is so important!