The relative strength index (RSI) is a technical momentum indicator that compares recent price gains against recent price losses. It is primarily employed by traders and analysts to indicate possible overbought or oversold conditions in a market.
How Does the RSI Work?
RSI readings range from zero to 100, with readings above 70 generally interpreted as indicating overbought conditions and readings below 30 indicating oversold conditions. Since the RSI measures the magnitude of recent price movements, it is most prone to generating false signals following sudden, sizable price changes.
Generally, as the price of an asset rises, the RSI will rise as well, because average gains will outstrip average losses. When the asset price falls, losses typically outstrip gains, causing the indicator to fall.
What Indicators Can Be Used Along With RSI?
Some of the best technical indicators to complement using the relative strength index (RSI) are other momentum indicators, such as the moving average convergence divergence (MACD) and moving averages.
Moving Average Convergence Divergence (MACD)
One technical indicator that can be used in conjunction with the RSI and helps in confirming the validity of RSI indications is another widely-used momentum indicator, the MACD. This indicator calculates momentum in a different way than the RSI does, by comparing the relative positions of a short- and long-term moving average.
Traders primarily monitor the MACD for signs of momentum diverging from price. While price may continue to move up, with the RSI maintaining overbought readings for quite some time, the MACD shows divergence by beginning to turn down as price continues to advance. This provides an additional indication confirming that a market may be reaching a level where it is overextended and therefore likely to retrace in the near future.
Moving Average Crossovers
Moving average crossovers can also be used to provide confirmation of RSI indications that a market is overbought or oversold. Since the RSI is often used to obtain an early indication of possible trend changes, using exponential moving averages (EMAs) that respond more quickly to recent price changes, and relatively short-term moving average crossovers, such as the 5 EMA crossing over the 10 EMA, is best suited to complement the use of the RSI. The 5 EMA crossing from above to below the 10 EMA is a confirming indication of overbought conditions and possible trend reversal, while an upside crossover provides an additional indication that a market may be oversold.