Posted by forex at 8:20 AM
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1. Use the RSI to compute broad trends in the market. The RSI should be used in connection with other technical indicators such as the 200 and 50 day moving average. Know that RSI is used for bonds, stocks and commodities. It is simply the average of two averages. Thus, traders should use it to confirm the strength and direction of a market move. There is no proof the RSI is any better than any other indicator.
2. Understand the RSI is commonly computed with a 14 day moving day average. RSI compares the relationship between the number of up days in a short moving average divided by the number of down days of the same average. This result is manipulated into a number between 0 and 100. Important signals occur between readings of 30 and 70.
3. Prepare to trade when the average reaches a low reading of 30. Understand that a stock may be still dropping or bottoming. Bottoming stocks will have low reading and a sideways move in the RSI. Do not buy a stock when it drops below 30. Wait until it exceeds the 30 reading and you have confirmation of the move from a price rise above the 200 or 50 day moving average depending on your investment horizon. Before it rises, it will probably go sideways for a period of time.
4. Trade stocks that have been in a trend and have risen above the 70 threshold. However, do not trade the security until it falls below the threshold. Stocks in a strong uptrend may continue above the threshold for extended periods of time. Look for the corresponding coincident signal from another indicator before selling.
5. Use RSI divergence as an important trading indicator. Divergence occurs when a stock price and the RSI move in different directions. Bullish divergence is when a stock price makes a lower low than in previous trading and the RSI indicator makes a higher low. Bearish divergence is when a stock makes a new high but the indicator does not. Use divergence as a more important trading signal than absolute number readings. Trade only with confirming price indicators.