The RSI (Relative Strength Index) is a widely used indicator in the technical analysis of financial markets to measure the speed and magnitude of price changes of an asset. Developed by J. Welles Wilder Jr. in 1978, it helps traders and investors identify overbought and oversold conditions, as well as possible trend reversals.
How Does It Work?
The RSI is a momentum oscillator that ranges between 0 and 100. Its interpretation is based on two main thresholds:
- Above 70: Indicates that the asset may be overbought, suggesting a possible price correction (down).
- Below 30: Indicates that the asset may be oversold, pointing to a potential appreciation (up).
RSI Calculation
The RSI formula considers averages of price gains and losses over a defined period (usually 14 days):
Divergences: Important Signals
- Bearish Divergence: The price reaches new highs, but the RSI does not confirm, indicating weakening momentum.
- Bullish Divergence: The price marks new lows, but the RSI does not follow, signaling a possible reversal to the upside.
Practical Applications
1. Identification of Entries/Exits:
- Buy when the RSI is below 30 (oversold).
- Sell when the RSI exceeds 70 (overbought).
2. Trend Confirmation:
- RSI above 50 suggests an uptrend.
- RSI below 50 indicates a downtrend.
3. Risk Management: Helps in defining stop-loss or take-profit.
Limitations
- In strong trends, the RSI can remain in overbought/oversold zones for long periods, generating false signals.
- Works best in sideways (ranging) markets.
- It is recommended to combine with other indicators (e.g., moving averages) for greater reliability.
Conclusion
The RSI is a versatile tool for analyzing momentum and market conditions, applicable to stocks, forex, cryptocurrencies, and other assets. However, its effective use requires practice and combination with other analyses, avoiding decisions based only on a single indicator.