The Secret Guide To RSI Indicator-Explained

The Relative Strength Index (RSI) is one of the most used indicator among traders. If I were to list the best trading indicators, RSI would be one of them.

In this article, I will discuss the Relative Strength Index. It is one of the most powerful tools to keep on your list to boost your trading. It can help a trader to find or understand the direction of price momentum. It can also help to find reversal trading opportunities, which is why most technical analysts use it in their day-to-day trading activity.

What is RSI Indicator?

The RSI stands for Relative Strength Index.

The Relative Strength Index (RSI), invented by J. Welles Wilder, the rsi is a momentum oscillator that measures the speed and change of price movements. Most traders think this is a strength showing indicator as it has ‘Strength’ in its name, but it is not. 

The RSI moves between 0 to 100. and most of the time, an RSI above 70 is considered overbought and oversold when it is below 30.

But we should not use RSI to see overbought or oversold zone. It is a momentum indicator, and we should use this to spot the trend, as the overall objective of RSI is to measure the change in price momentum.

Note: Charts used in this article are taken from TradingView. To know more about TradingView Read this article – Best Backtesting Software for Stocks and Options-Explained

How does the RSI indicator work?

To understand how the Relative Strength Index works, I will explain the RSI formula so that you understand it correctly.

The Formula to Calculate RSI is as follows;

Relative Strength Index = 100 – 100/1+RS

RS = Average gain over a specified period / Average loss over the same period

This formula is not that hard. It’s easy; let me explain this to you step by step. And then, we will see how you can implement this in your day-to-day trading activity.

Let’s assume RSI is for 14 periods, And for that, we will calculate the average gain over the last 14 periods, which means over the previous 14 candles, whatever your trading time frame is. For example, if your trading timeframe is daily, we will calculate the rsi for the last 14 days.

Let’s understand this with Adani ports stock; suppose Adani Ports stock moves 200₹ over the last 20 days the average gain of Adani stock will be 10₹. How I get 10₹ is I divide 200₹ gain by 20 days because we are using a 20 Period RSI.

And for an average loss, I will do the same as the average gain; I will change the average gain with the average loss and calculate it.

For example:

• If average gain = 10₹
• and average loss = 5₹

Then we will divide 10₹ by 5₹, which is equal to 2. and then we will add this value to our formula as RS = 2;

So,
RSI = 100 – 100/1+RS (formula)
= 100 – 100/ 1+2
= 100- 100/3
= 100 – 33.33
= 66.67

The RSI will be about 66.67.

Let’s try one more example with an average loss of more than the average gain.

• If average gain = 5₹
• and average loss = 10₹

RS = Average gain / Average loss
= 5/10
= 0.5

So,
RSI = 100 – 100/1+RS
= 100 – 100/ 1+0.5
= 100- 100/1.5
= 100 – 66.66
= 33.34

The RSI will be about 33.34.

The important thing to notice here is that the higher your average gain, the higher your RSI will be, and the lower your average gain, the lower your RSI will be.

I hope you understand how this RSI formula works! It’s nothing hard to understand, though.

So,

1. When RSI goes up?
2. When RSI goes down?

When RSI goes up?

RSI goes up when the average gain is greater than the average loss. That means the size of a bullish candle will be bigger than a bearish candle.

When RSI goes down?

RSI goes down when the average loss is greater than the average gain. That means the size of a bearish candle will be bigger than a bullish candle.

That is all basic about the Relative Strength Index, and I hope everything till now is clear to you.

RSI indicator Settings

Before I tell you the best rsi period, it is essential that I also tell you about the upper and lower bands of rsi.

Although there is no specific range, if you ask technical analysts, some say 70 and 30 are better, and some say 60 and 40 are better.

I mostly use 60 and 40 for my intraday trading and 70 and 30 for my swing trading. I don’t know how correct it is, but personally, it is helpful, so I keep using these settings for myself.

There is no specific period that I will give you here, and you will be a successful trader; no, things don’t work that way. Every trader uses this as per their needs and requirements, or I can say which suits their trading style. Some use 7, 9, 10, 11, or 14.

They tested these periods for themselves and checked which was okay for their trading style.

The rsi period I use is 14, which helps me a lot for intraday trading in stocks and indices, and for me, it gives pretty reliable trading signals. But I don’t use rsi blindly; I use rsi by combining other trading signals.

I use rsi for breakout trading and to check divergence. There are two types of divergence, bullish rsi divergence and bearish rsi divergence.

Most beginners use rsi divergence in the wrong way. They just saw divergence and jumped into the trade. Just because they see bullish divergence rsi or bearish divergence rsi, it doesn’t make sense to take an entry opposite to the trend.

How do I use RSI to confirm my breakout trades?

It is not easy to find which breakout will be successful or failing. Most traders suffer when it comes to taking breakout trades. But don’t worry; I will show you a straightforward method in which we will use rsi to confirm our breakouts. This method is beneficial to me when it comes to taking breakout trades.

I will show you a powerful way to use RSI (or I can say secret way) and filter out your breakouts in the market. I use this strategy in intraday trading with stocks or indices (Nifty 50 and Bank Nifty).

Check out the below example to understand it clearly.

I was looking for a trading opportunity in nifty on 28 July 22, And I found a Bull Flag pattern in the Nifty chart. There was a resistance of 16741, and If you see RSI with it, you will find RSI has a resistance of 71.87. Then the price retraced and made the bull flag pattern, and on 27 July 22 in bull flag pattern breakout happened, and the price close.

But still, there was resistance. For price 16741 was resistance and for rsi 71.87 was resistance. On 28 July 22, the Nifty opened the gap up; it was not a normal gap up. We call it the breakaway gap. As you can see in the above chart image, This breakaway gap did break out of the price and rsi resistance level.

I enter when a strong candle confirms the move. In this trade, I get more than a 2% reward. If you see at RSI, after a few candles, rsi was starting to fall, but still, the price was going up, or I can say rsi was in the overbought zone, but as you can see, the price was still going up. That shows us it doesn’t matter when a trend is vital, whether rsi is falling or rsi is in the overbought zone.

Here I don’t use only rsi, but I use other factors to confirm my trade, which is as follows;

• Strong uptrend
• Bull flag pattern
• Breakaway gap
• Price and RSI breakout

Note: There is 1 Rule in this strategy, Price and RSI should break the level together.

Let’s check one more example.

In TCS stock, The ongoing downtrend was going on. As we can see, the price was making Lower Low Lower High, and on 29 July, It faced resistance on the 3223.15 level and retracted back and, in doing so, form Higher Low.

For the price, 3223.15 was resistance, and for RSI, 75.15 was resistance. On 3 Aug, the price did break out, and rsi also supported this breakout as rsi also broke the 75.15 level.

As you can see, rsi was in an overbought zone, but still, the price was going up. Then we can see rsi fall, but the price goes up and up as it was a strong trend. (trend reverse from down to up)

Here I don’t use only rsi, but I use other factors to confirm my trade, which is as follows;

• Reversal in a downtrend
• Higher low break Lower High
• Price and RSI breakout
• Breakout with a strong candle

How do I use RSI Divergence?

Before I explain how to use rsi divergence or types of rsi divergence, let me give you a simple walkthrough of what I mean by divergence.

Divergence means when a stock’s or security’s price moves opposite of a technical indicator, such as an oscillator.

In our case, there will be differences between price and rsi; we call that difference rsi divergence.

There are two types of divergence in rsi, which are as follows:

• Bullish rsi divergence
• Bearish rsi divergence

RSI Divergence Bullish

RSI bullish divergence occurs when the price keeps making a lower low and lower high, but the rsi starts to make a higher high and higher low. RSI divergence bullish is the signal of a trend reversal.

See the example below to understand better:

As you can see in the above chart image, the ongoing trend was a downtrend. And price held the same level, but rsi started to make higher lows, and then the trend reversed from down to up.

Here you can also see the breakout, in which rsi supported the breakout with a price.

RSI Divergence Bearish

RSI bearish divergence occurs when the price keeps making a Higher High, but the rsi starts to make a Lower High. RSI divergence bearish is the signal of a trend reversal.

See the example below to understand better:

As you can see in the above chart image, the ongoing trend was an uptrend. And the price was making Higher High, but on the other hand, rsi was making lower high. And then the trend reversed from up to down.

Check my recent trade example:

On 15 Sep 22, Nifty 50’s overall trend was uptrend, but the price was facing resistance around the 18080 level, and rsi also showing rsi divergence bearish, but the price was on the same level. It was a double top chart pattern, and my entry activated when I got a strong bearish candle on that level. I get more than a 2% target on this trade.

Here I don’t use only rsi divergence bearish, but I use other factors to confirm my trade, which is as follows;

• Price was on an uptrend but faced resistance on the 18080 level
• Double top chart pattern
• Strong bearish candle on resistance
• RSI Divergence Bearish

Conclusion

As a trader, we should not use rsi blindly. We should use other factors also to confirm our trading entry exits.

14 RSI period is helpful as I tested and used it many times in my trading. It gives me pretty reliable trading signals. You can try this or any other periods, but before using them directly in your trading, you should backtest them and check whether they suit your trading style.

I use the rsi band 60 40 for my intraday trading and 70 30 for my swing trading. It is beneficial to me. RSI divergence helps to take reversal trades. Overbought and oversold concepts are not as helpful as you can see in the above examples.

In the end, RSI is another tool helping a trader sharpen his edge. Don’t entirely depend on any one signal for your trading.

I hope you found this article informative and that it will be helpful to you in your trading. You can comment below if you have any doubts about this post’s content, and I’ll solve your doubts as soon as possible.