Oscillator Example – Relative Strength Index (RSI)

The relative strength index (RSI) is a popular oscillator that measures the extent of recent price changes to determine overbought or oversold conditions in an instruments price. J. Welles Wilder Jr. developed the RSI and first shared it with the technical community in his book “New Concepts in Technical Trading Systems.”1 It has become one of the most trusted indicators for anyone planning to use oscillators to determine buy and sell points.

In the example below, you can see Microsoft Corporation’s (MSFT) lower range of the relative strength index (RSI) is 30 and the upper range is 70. The mid-range is 50. The consensus amongst technical analysts is that the RSI becomes oversold at the 30 level and overbought at the 70 level.2

These levels are not set in stone, rather they are commonly used levels to gauge a stock’s overbought / oversold levels. Some charts and theories would use 20/80 as the low/high boundary. For some technicians, these numbers may be far too conservative, causing the trader to be too late on the buy-side and therefore miss out on capital gains. Also, if traders use the 80 high mark, they may miss the true selling point on the overbought side.

Arrows are shown at the entry points at which the RSI bounces off the 30 level. By drawing a horizontal channel between the $66 and $72 price levels, we have marked the horizontal trading pattern. Notice that the RSI tends to remain well above 50 while the price action is inside this horizontal channel. Here the RSI shows a somewhat overbought situation, but no major selling pressure is evident. Many investors believe Microsoft can be purchased at any level because they will hold it in their portfolios for the long-term and are not concerned with trading it short-term.

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