How to Use Relative Strength Index (RSI) On Stocks

Using The RSI Stock Indicator [Properly] Provides Accurate Insights Into Stock Price Trend Changes. Learn the Settings, Calculations & Techniques

In this article, we discover the Relative Strength Index stock chart indicators, possibly the most used chart indicator in technical analysis.  But most people do not know how to use it properly.

Relative Strength Index (RSI) Explained
Relative Strength Index (RSI) Explained

What is the RSI Indicator

Developed by J Welles Wilder, the Relative Strength Index or Wilders RSI indicator measures the strength of any stock or market index, by analyzing its price movements.  RSI measures price relative strength by using average net up closing day prices versus its average net down closing prices for the period set.

RSI enables you to evaluate if a stock is overbought or oversold.

How Is RSI Calculated?

RSI fluctuates between 0 and 100, RSI less than 30 indicates the stock is oversold, and above 70 suggests a stock is overbought. RSI is considered a leading indicator and thus can be used to predict future trend changes using positive or negative divergences compared to price.

Divergences are one of the most powerful ways to use most indicators. The fact that it is a leading indicator, as opposed to Moving Averages, which are lagging, and can thus indicate future directional changes.

The Best RSI Indicator Settings

There is no “best” setting for RSI; you actually need to tune the RSI settings for the timeframe in which you want to analyze a stock trend.

  • A Short-term RSI Setting RSI 7 (7 Periods of Price: Good for Daily or Intraday Charting)
  • A Medium-term RSI Setting 14 (14 Periods of Price: Good for a Daily Chart)
  • A Longer-term RSI Setting 20 (20 Periods of Price: Good for a Weekly Chart)

Tune the RSI setting based on the timeframe.  If you want to see the stocks strength over a period of weeks on a daily chart, you could use RSI 20, which indicates a 1-month trend (20 market days in a month).

If you prefer to trade short-term on an hourly chart, you might use an RSI 24 to see three days of trend (24 hours or 3 market days).

Relative Strength Investing

The chart below is of Smith & Wesson (SWHC); the chart shows clearly how RSI can be used to clearly predict future trend changes.

In this chart, I use RSI in two separate windows on two different settings to show how the shorter and medium-term settings can show a different line but draw the same conclusion. This means they are confirming each other, which is a key concept in technical analysis of stock charts.

Review the chart, and read below the five key points explaining usage.

RSI 5 Point Analysis - Detailed Example Chart
RSI 5 Point Analysis – Detailed Example Chart

TC2000 RSI Chart – Get TC2000 Free

Relative Strength Chart 6 Step Explanation

  1. Trendline showing the price highs trending downward from the period November to February.
  2. During the same period, we see the price lows trending higher.
  3. The two trendlines indicate the forming of a Price Pennant, but which way will the stock price go, up or down? For the answer, we refer to the leading indicator RSI.
  4. The RSI 7 (Orange Line), indicates as early as the beginning of January that there is strong upward momentum in RSI, although this is not reflected in the price, it is the underlying action.
  5. The RSI 14 (Purple Line) also confirms the shorter timeframe RSI setting but gives us a smoother line, which can be easier to interpret.
  6. Finally, in mid-February, the stock price bursts through the price high trend Line (point 1 above), and the stock proceeds to double in price, gaining 100% in 5 weeks.

What a great result, and what proof that RSI has real meaning and application.

Divergence Is The Key to RSI

The important lesson here is to notice when the Relative Strength Index moves in the opposite direction to the stock price.  The indicators moving against the price is called a divergence.  Spotting divergences are essential to use with the majority of stock market chart indicators.

Stock Market Analysis Using RSI

During the 2020 Corona Crash, I used RSI to help stop the serious impending stock market crash and also the subsequent recovery. The S&P500 chart below shows how to use RSI with other indicators to draw conclusions on market trend change.

The RSI Indicator Was Helpful in Spotting the Market Bottom in 2020
The RSI Indicator Was Helpful in Spotting the Market Bottom in 2020 (Click to Zoom)

This chart was built using TradingView, our review winning best stock market software. You can get TradingView for Free.

The Best Indicators to Use With RSI

There may not be any “best” indicator to use with RSI, but you should select indicators that perform different calculations. RSI is a price indicator, so in addition to RSI, you should use a price and volume indicator such as OBV or Money Flow. When RSI and OBV or Money flow both agree in direction, it is a reliable way to interpret trend direction.

In the market analysis of the Corona Crash I used RSI with the Advance-Decline Ratio (ADR), the Know Sure Thing (KST) indicator, and the Volume Indicator with a Moving Average 20 line.

When Not To Use RSI

Stock chart indicators never work perfectly all the time. If the RSI indicator is telling you nothing important, then please use other indicators, or move on to review another stock where the indicators will tell you something.

To control your investment, your money and your destiny take hard work, but the fruit will be sweet.

Best RSI Stock Chart Software & Screeners

  • TradingView The Number 1 Stock Charting Tool with RSI Indicators.
  • TC2000 Best for US Charts With RSI Indicators & Screener Analysis
  • MetaStock Best for Backtesting & Forecasting With RSI
  • TrendSpider Best For Automated Technical Chart Analysis

Compare The Top 10 Stock Charting Software Platforms Comparison

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3 COMMENTS

  1. Thanks Barry for the post..
    You explained some interesting indicators in this section/grade.. Can you give us a prioritized list of the indicators that you use when using the charts? for swing trade for few months to a year? Thanks again
    AC

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