Overbought, Oversold, Divergences in Relative Strength Index (RSI) indicators and determining support and resistance levels for buy and sell signals


Overbought, Oversold, Divergences in Relative Strength Index (RSI) indicators and determining support and resistance levels for buy and sell signals
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12/31/2022



Relative Strength Index (RSI). It is an indicator developed by J. Welles Wilder, based on Momentum, but with improvements. That usually happens with Momentum 2 things:


1. If you use very unusual past data, it will cause the Momentum that has changed to happen. In spite of the current price there is very little movement.


2. The problem of finding the standard zone to capture the exact OB/OS zone. Remember that in Momentum we only have a zero line. Only tell (or line 1 or 100 in the case of Rate of Change), but we can't say how high the momentum must go up to be called as overbought and how low to be called as oversold.


Hence, the RSI was invented to solve that problem. The calculation formula is as follows:



rsi-calc.jpg



Provided that RS - is the ratio between The 7-day exponential moving average of gains versus the 7-day exponential moving average of losses (regardless of the mark) number of days used. Like any other oscillator, with a small number of days, the RSI is very sensitive to changes. Suitable for those who like to speculate day-to-day or during the day There are 4, 9 and 14 days that are commonly seen. In addition, the RSI is also a tool used to measure hardness. Of the stock price whether it fluctuates in a way that is driven or has inertia How much, this RSI value is always between 0 and 100. If the RSI is high, it indicates that in the past several days. The price has moved higher than it has decreased. A low RSI value indicates that the price in over the past few days On average, it decreased more than increased.


The rules that apply to the widely used RSI are as follows:



  • Overbought, Oversold The overbought area is usually set at the RSI level above 70 or higher, which means that the price has moved up very high. And they are already overbought. On the other hand, if the level is below 30, it is considered oversold, which in itself indicates that the price has moved down a lot.


  • Some people may wait for the 30 line to start to cross before buying. But some people may be a little impatient, just let this line start pointing up in the oversold area (or pointing down in the overbought area in case of selling) by using the moving average of the RSI as a signal. Have started trading Because he is afraid that until he crosses the 30 line, it may be too slow (or cuts the 70 line down in the case of selling), which the techniques of each person may be different. Or bizarre together but how to use it should It also takes into account the past behavior of the RSI with its price during that period. Because there are many times at consideration Just this may give erroneous results. Therefore, the rules that will be mentioned next should be taken into consideration together.


  • Price patterns which may not be apparent. But it usually manifests or is found first in the RSI, which can be an early warning signal. Before that incident in price action Let's look at the example. Below, you can see that a Head and Shoulders pattern has been formed in the RSI as shown by the Neck Line, but that pattern has not formed in the price at all.


  • Resistance or support levels may be seen more prominently on the RSI in price. Like the example below as well You can clearly see that the trend line drawn up on the RSI has acted as support. And resistance to the RSI, which is the support On the other hand, resistance becomes a selling point if the RSI fails to break above. If you look at the relationship between the RSI and the price, you can see that it does not give a bad signal.


RSI 02.png



The so-called divergences occur, for example, the price has broken through the previous peak, while the RSI itself has failed to break. Its original balance This is an early warning that there is a chance that the price will decline in the future. This is because the RSI is a measure of momentum. Even if the price continues to rise, the RSI may decline due to the price inertia.


Divergence signals between the RSI and the price are often seen when the RSI fails or fails to swing. For example, while the RSI is in an upward direction and above the 70 line (overbought), but cannot create a new higher top and a new lower bottom. This is called Top Failure Swing, or on the contrary, if the RSI is below the 30 line (Oversold) in a downward direction but can create a new Higher Top and Bottom, it is called Bottom Failure Swing, which will be a reversal signal.


We can see that the important signs This will happen mostly in the OB/OS bands. As mentioned above, the RSI performs best in this area and another important divergence characteristic in the OBIOS area is that the RSI fails to break the resistance from the tops or the OB/OS bands. If the old base is gone, it will warn of the upcoming reversal.




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