5 Trading Strategies using Relative Strength Index
The job of a trader is to look for trading opportunities in the stock market. Indicators can undoubtedly help in this regard when used correctly. It is no different with the Relative Strength Index. Correctly used, it can aid in predicting rising momentum, underlying demand or supply, and sentiment shifts.
The indicator can also predict trends, trend reversals, trend continuations, and stagnate corrections. With practice and a firm understanding of volume and price action, the RSI indicator can be a useful tool in your trading arsenal. To determine how well a stock performs relative to itself, the Relative Strength Index (RSI) compares up days with down days.
Here are some trading strategies and how to use the RSI indicator in today’s blog:
What is Relative Strength Index?
In June 1978, J.Welles Wilder published New Concepts in Technical Trading Systems, which described the RSI in detail. Relative Strength Index (RSI) measures how well a stock performs relative to itself by comparing up days versus down days. There is a range of 0 to 100 for this number. A reading of 70 or higher is considered bullish, while one of 30 or lower is considered bearish. Tracking periods of overbought or oversold conditions is generally helpful.
How to use RSI?
The RSI Indicator can be used in the following ways:
If the RSI rises above 70, it is considered overbought; if it falls below 30, it is considered oversold. If necessary, these traditional levels can also be adjusted to fit the security better. If security consistently reaches the overbought level of 70, you may want to increase it to 80.
The RSI may remain overbought or oversold for extended periods during strong trends.
Chart patterns formed by RSI may or may not be visible on the underlying price chart, such as double tops, bottoms, and trend lines. RSI can also be used to find support or resistance.
3. Trending Market
During an uptrend or bull market, the RSI tends to remain in the 40 to 90 range, with the 40-50 zone acting as support. During a downtrend or bear market, the RSI stays between 10 and 60, with the 50-60 zone acting as resistance. Ranges will vary depending on the RSI settings and the strength of the underlying trend of the security or market.
RSI divergence may indicate a price reversal if underlying prices make a new high or low that the RSI does not confirm. In a Top Swing Failure, the RSI makes a lower high and moves below a previous low. A Bottom Swing Failure occurs when the RSI makes a higher low and then rises.
After understanding how to use the RSI Indicator in trading, let’s discuss some strategies:
Trading Strategies using RSI
1. RSI with MACD
The chart below shows Ultra Cement Ltd.’s 15-minute performance. We receive entry signals from both indicators at the times indicated by the green circle in this relative strength index example. The relative strength index leaves an oversold condition slightly more than an hour after the morning open, which is a clear buy signal. The MACD also performs a bullish crossover the following period, which is our second signal.
2. RSI with MA Crossover
This trading strategy matches the RSI with the moving average indicator. Moving averages will be calculated using the 4-period and 13-period moving averages. We will buy or sell a stock when the RSI crosses the 50-line and the moving averages crossover in a positive manner. That being said, we will hold the position until we see a divergence on the chart or a reversal signal from one of the two indicators.
To begin with, let’s clear up some confusion about MA cross-exit signals. Trading should not be terminated based on a regular deviation from the moving average. We recommend waiting until a candle closes above both lines of the moving average cross before exiting the market.
RSI crosses the 50-line co-incidence with MA crossovers on the daily chart of State Bank of India Ltd., indicating a bullish entry signal. Conversely, we can exit the stock when the RSI crosses the 50 lines from above and there is a bearish MA crossover.
3. RSI and Price Action Trading
We will use the relative strength index signals along with any price action indicator, such as candlesticks, chart patterns, trend lines, channels, etc.
RSI signals and price action signals – candle patterns, chart patterns, or breakouts – are required to enter a trade. Each trade should be held until a contrarian RSI signal or price movement confirms that the move has ended.
RSI also entered the bullish territory on the daily chart of State Bank of India Ltd as candlesticks formed a Morning Star Pattern. We can enter the stock based on both the RSI and candlestick patterns.
4. RSI and Relative Vigor Index
For this RSI trading strategy, we will combine the relative strength and vigour indexes. You will only enter the market if both indicators produce matching signals. Hold the position until one of the tools gives you the opposite signal.
5. RSI with Keltner Channel Indicator
For long entries, we examine the Keltner Channel’s slope, while for short entries, we examine the slope downward. We look for buy entries when the RSI closes above 50 and the Keltner Channel slope is upward. Short entries are looked for when the RSI falls below 50, and the Keltner Channel slopes downward.
In the long market, we place our stop-loss order below the Keltner Channel, and in the short market, we place our stop-loss order above the Keltner Channel. To ride the trend as much as possible, we should use a trailing stop.
It is a good idea to combine the relative strength index with another indicator, such as volume or moving averages, if you are new to trading. If you pair it with an indicator, you will get a fixed value. In addition, it eliminates many of the ambiguities associated with trading.
You may want to consider more subjective price action methods as your trading career progresses. The security you are trading may also allow you to apply techniques specific to it, increasing your winning percentages over time. The practice required to achieve this level of trading takes time.