How to Use RSI Indicator to Trade Stock & Binary Options

The RSI or Relative Strength Index indicator is bounded momentum based technical indicator that attempts to predict a change in momentum.

The RSI value oscillates between 0 to 100 and is calculated using the average gains and losses of an asset over a predefined look-back period.

Visual Representation of the RSI Indicator

The Relative Strength Indicator is plotted below the price chart as a line chart that ranges between 0 and 100.

Chart showing the RSI (Relative Strength Index) Indicator with overbought and oversold levels

An upper and lower band indicating overbought and oversold levels are also overlayed across the RSI chart. Sometimes, a centerband at the 50 level is also visible on the RSI chart.

When the RSI rises beyond the upperband, the asset is considered overbought. If the RSI drops below the lowerband, then the asset is considered oversold.

RSI Parameters

Overbought & Oversold Levels

Traditionally, according to Wilder, the oversold level is set at 30 while the overbought level is set at 70. However, short term traders might want to set a tighter range of 80-20 to reduce fake outs.

Raising overbought to 80 or lowering oversold to 20 will reduce the number of overbought/oversold readings.

Look-back Period

The default look-back period for RSI is 14.

Increasing the look-back period will decrease the likelihood of hitting the overbought or oversold levels. Conversely, decreasing the look-back period will increase the sensitivity of the RSI and leading to more overbought/oversold conditions being reached.

RSI Centerline Crossover

Many traders also uses the RSI centerline crossover event as a trend confirmation indicator.

Chart showing the RSI Crossover events

Whenever the RSI rises pass the 50 mark, it can be seen as a bullish trend confirmation.

If the RSI drops below 50, a bearish trend is being confirmed.

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