One of the aspects I teach through Chart Pattern Manifest is how to use a host of indicators and then integrate them into your overall stock charting analysis as needed.
As the markets have started to dip over the last couple of days, I thought it would be appropriate to share an indicator that I like to use, which also helped me see this down price movement come before it even happened.
Its called the relative strength index (RSI) and measures the magnitude of a stock’s recent gains to its recent losses. It is useful for determining momentum of a particular stock. It is an available feature on most stock charting applications. The one I commonly use it on is stockcharts.com.
Note: RSI should not be used alone as a basis to buy or sell a position, rather it is best used with a combination of other technical tools.
RSI is a line that fluctuates between a scale of 0-100 based on the stocks momentum. In general RSI ranges between 30 and 70. Below 30 classifies oversold and above 70 distinguishes overbought. Many traders look at RSI falling below 70 as a bearish signal and breaking above 30 as a bullish indicator; however, many also look at the 50 mark as a transition of ultimate trend reversal.
The only customized option for RSI is the period length you want to examine. Obviously long-term traders will prefer extended periods such as 30, while many swing traders will find 14 more significant. It is up to the trader to play around and determine which is best for them.
I have more in-depth RSI examples in Chart Pattern Manifest; however, I thought we should look at a couple current examples of how RSI could have prevented you from losing any profit.
You’ll notice that the momentum of the stock above picked up once the RSI crossed back above 50, which is considered a bullish trend reversal. Eventually the stock hit massive overbought levels near 90, and should have triggered you to sell or at least take some money off the table. Subsequently the stock dipped lower from there.
Now as the RSI heads closer to 50 this could either regain positive momentum with a RSI bounce higher or dip lower with RSI going below 50.
The chart above shows you a good example of how to use RSI both for long-term and short-term trading goals.
More active traders could use bounces at various levels to make individual trades to capture each momentum swing; however, other traders would prefer to hold on to a stock as long as it stays in bullish territory. For example, if you just held on to this stock from the second it bounced off the 30 line at $15 and continue to hold as it stays above 50, then you still made a 7 point profit.
In the example above, we see a prolonged RSI movement. Instead of jumping from 30 to 70, the stock’s RSI bounced off 30 and huddled around 50 for a couple of weeks, which made the trend unclear. Eventually the RSI crossed over 50 and stock followed from $15 to $17 before bouncing off 70 RSI level.
For more indicators, patterns, and other technical analysis skills, check out Chart Pattern Manifest.