RSI Oscillator has a history that begins from a long distance; it was 1978 when a particular book of technical analysis appeared, “New concepts in technical trading systems” this text would change the way of studying the financial markets.
You remember Welles Wilder, a former mechanical engineer who left his job in the early 1970s to engage in financial markets and their analysis.
He understood early on something that later became fundamental in the analysis of financial markets: he realized that the way of doing analysis had to be changed by constructing mathematical indicators, but tried to describe what the analyst observes visually and what the experience of financial markets teaches to those who are experts in the field.
The result of Welles Wilder’s research a tool is invented that had a high diffusion and is known by the full name of Relative Strength Index that turns the role of an excellent momentum indicator let’s find out how RSI works and so that it can quickly become a valuable resource for investment in financial markets.
How the RSI Oscillator works
The basic concept on which RSI was built is straightforward: it is based on the fact that when the price is stable then the higher the upwards than the downwards closures, quite the opposite happens when the cost is in a phase of weakness, the downwards closures at that point will undoubtedly be higher than the upwards closures.
So we are talking about an indicator very similar to the stochastic one, as we mentioned before. Still, here the market strength is calculated in a much simpler way than the stochastic one for which the comparison is made between the closing level and the minimum range of a specified period.
RSI, on the other hand, is based on whether upward closures weigh heavier than downward closures.
Of the two directions, the ones that weigh the most indicate the prevailing direction of the market.
However, when we talk about the averages of positive and negative closures, we will not go to calculate the moving averages of closing sessions with positive or negative closure. Still, in reality, it is a matter of adding the positive price differences of the last 14 meetings and dividing this sum by 14 months ago by the negative price differences.
The RSI oscillator varies between two values of 0 and 100. The SRI will be 0 when in the last 14 sessions, there has been no positive closure, while it will be 100 when there has been no final positive price change in the previous 14 meetings.
Welles Wilder has also taken care to provide us with guidance on how to read and interpret data from RSI. The levels considered necessary by the same scholar are the area above 70 points and below 30 points.
Those who take advantage of the RSI oscillator and usually indicate these two particular areas as overbought when we are above 70 points, and oversold when we are below 30 points.
So let’s take a closer look at what is meant by overbought and oversold, although there is no trace of these terms in Wilder’s book and studies.
Hypercurchased: this is called the phase in which the indicators themselves reach their peaks; these conditions generally occur when the price itself has pushed, according to mathematical calculations, towards its ascending limits and therefore is destined to reverse its course.
Hypervended: the same is true for the overselling phase; here too, the RSI has reached more or less its maximum, indicating that the price has reached a downward limit area, and the market could soon generate a bullish reaction.
RSI is a handy indicator for investors and is well understood precisely by looking at the definitions we have given of overbought and oversold.
When the price is brought to these limit areas, the operational indications offered by the market analysis with the RSI become clear with unparalleled clarity, let us, therefore, try to understand what types of positions can be opened by observing the RSI oscillator.
Entering the long market: by assessing the situation well, you can open a buying position on the asset when the RSI shows a case of overselling, that is, you must observe that the indicator line falls below the value of 30.
Enter the short market: in turn, a downward reversal could occur if the market is in the limit area of the hyperbought.
It is unlikely that the market will be able to sustain those rhythms, and therefore the reversal could occur soon, at a time when the RSI line is above the value of 70.
RSI is an indicator that can provide very reliable trading signals, but as always, the advice is to combine the data it contains with those of other indicators.
There are many equally easy to read indicators that can make the pair excellent with RSI; we are talking, for example, about Mobile Media, an indicator of which we have already highlighted the qualities and qualities, as well as how to use it in another article.
This indicator, like all others, can in some cases generate false signals because being perfect for indicating momentum changes does not always suggest trend changes through them, which is why many traders tend to use RSI as a simple aid to graphical analysis, but if exploited with the right awareness when reading a graph can provide valuable indications and allow you to promptly intuit the most given moments to enter or even leave a position.
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