Posted by forex at 1:42 AM
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Basics
1.
Create an RSI chart. In days past, traders would use the formula to crank out RSI values and plot them by hand. Hardly anybody does that today. Most charting platforms will automatically calculate and plot RSI instantly. In any event, starting with a graphical representation of RSI is an essential first step.
2. Find the current RSI value. This should be listed in the upper left of the indicator. It is usually a number between 0 and 100. The number in parenthesis is the number of periods used to calculate the RSI value, typically 14.
3. Establish a broad outlook based on RSI value. Traders typically see RSI below 50 as putting a bearish tilt to the stock. A reading of RSI above 50 is bullish or trending upward.
4. Use the running line of RSI values in the main display to identify conditions of divergence or overbought/oversold.
Divergence
5.
Compare trends in RSI to identify divergence. Positive divergence, seen in green in the chart of Dell Computers, occurs when price trends lower. Divergence is always considered an advanced indicator of a change in trend. In this case, the positive RSI divergence was signaling a recovery and rally in shares of Dell.
6. RSI can also produce negative divergence. The negative divergence (shown in red) indicates that the new highs are too much to pay for shares of Dell Computers.
7. Once a divergence is identified, look for price to 'confirm' the divergence before placing a trade. If a positive divergence, risk is minimized by waiting until price begins to move higher and match the RSI before buying. Similarly, in a negative divergence, look for price to roll over and begin trending lower before selling. This will minimize risk.
Overbought and Oversold
8. Identify readings below 30 on the RSI as 'oversold.' Generally a buy signal, this a condition that occurs when a stock's price falls too far too fast. This information is useful to traders. Oversold conditions often represent excellent opportunities for buying stocks at deep discounts.
9. Identify readings above 70 on the RSI as 'overbought.' A sell signal, this is the mirror image of oversold. When a stock's price has risen too high too quickly, traders often use the opportunity to sell and take profits. Initiating a short position is wise.
10. Watch for a centerline cross. Use the horizontal at 50, or 'centerline,' to gauge whether a stock's average gains are higher than average losses. RSI crossing over 50 in either direction is usually considered a significant event. It represents a shift in the general performance of the stock.