Relative Strength Index

The RSI, or Relative Strength Index, is a misleading moniker for this reliable oscillator. When we speak of an equity's relative strength, many times we refer to its health as it relates to a broad market index such as the S&P 500, or the industry index where the stock resides, like the semiconductor index ($SOX.X) or the pharmaceutical index ($DRG.X).
The RSI does not compare two separate entities. Introduced by Welles Wilder in the June 1978 issue of Commodities (now Futures) magazine, and in his book published in the same year, New Concepts in Technical Trading Systems, the RSI operates as an oscillator that measures a particular stock's current relative strength as compared to its'own price history. When Wilder first introduced the RSI, he recommended using a 14-day time period. Now, 9-day and 25day RSIs are also favorites. The RSI is one of my preferred oscillators, and we're going to use it in our buying criteria. For multi-day to multiweek holds, the 14-day parameter works well (and is standard in most charting software). So, please stick to that time parameter for now. As you gain more experience, you may want to tweak the setting to a faster, or slower, time period.
As a price-following oscillator, the RSI is plotted on a vertical scale numbered from 1 to 100. It's considered to be oversold when it falls below 25, and overbought when it rises over 75.
Dandy features of the RSI are:
The RSI forms chart patterns, such as a double top or head-and-shoulders, which may not show up in the stock's price pattern.
The RSI may indicate support and resistance levels more clearly than the stock's price pattern.
The RSI makes a fantastic buy/sell decision support tool when it diverges from the stock's price action. For example, the stock may make a new high, but the RSI does not. That's bearish. Or, the price may tumble to a new low, while the RSI moves sideways or up. That's bullish. Prices usually follow the direction taken by the RSI.
To incorporate the RSI into your buy/sell criteria, you'll add it to the signals we already have in place, meaning the 1-2-3 entries, strong volume on the breakout, and price bouncing off a major moving average (such as the 20-day, 40-day, or 50day MAs). Now add the RSI. When you enter a position, you want it to appear in one of these ways:
Oversold, and hooking up from below 30.
Hooking up from below 50 and in an uptrend (making higher lows and higher highs).
Making a bullish divergence by rising when the stock price is consolidating, or pulling back, in the course of an uptrend.

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