Why Some RSI Indicator Strategies Are Wrong In Predicting Tops And Bottoms

rsi indicator
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I've sure you have heard about RSI or the Relative Strength Index before right? Most traders use RSI strategies when looking at the market to help spot extreme areas - above 70 or below 30 - signaling oversold or overbought stocks. Personally I think when you hear someone talk about this you should cover your ears and make loud noises until they stop speaking!

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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. It is usually considered that the stock is 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. Ask anyone who has tried to trade them after they just hit the extreme levels has almost certainly been stuck right at the beginning of a trend. 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!

How Do You Have RSI Set-Up?

There are a lot of different ways to setup RSI on your charts. Some traders use regular RSI, RSI with breakouts and then multiple time frames. Add your comments below and don't be afraid to share how you have RSI setup and what YOU look for with signals!

About The Author

Kirk Du Plessis

Kirk founded Option Alpha in early 2007 and currently serves as the Head Trader. In 2018, Option Alpha hit the Inc. 500 list at #215 as one of the fastest growing private companies in the US. Formerly an Investment Banker in the Mergers and Acquisitions Group for Deutsche Bank in New York and REIT Analyst for BB&T Capital Markets in Washington D.C., he's a Full-time Options Trader and Real Estate Investor. He's been interviewed on dozens of investing websites/podcasts and he's been seen in Barron’s Magazine, SmartMoney, and various other financial publications. Kirk currently lives in Pennsylvania (USA) with his beautiful wife and three children.