Day trading strategies using the Relative Strength Index vary based on the conditions of the market as a whole. In oscillating markets, markets that are ranging up and down regularly, the overbought and oversold indicators are commonly set at values of 70 and 30, respectively. When the RSI passes these values for particular stocks, traders should begin monitoring them. When the metric passes these values again in the opposite direction, relative strength suggests a shift in the trend, signaling a buy when a stock is oversold and a short when a stock is overbought. The index can be effectively used in contrarian trading strategies as well as channeling strategies, where traders focus on a single stock.
Unfortunately, simple overbought or oversold values can be weak signals of shifts in the momentum. The technique may or may not work depending on the situation. RSI divergences, on the other hand, are generally stronger indications of coming movement. A divergence is created when a stock reaches a new high or new low but its relative strength value is not as extreme as the previous peak or valley. A bullish divergence, for example, occurs when the price of a stock reaches a lower value than the previous valley, but the RSI does not reach as low as it did then. This indicates that the movement lower is not supported as strongly by momentum, often signaling a fundamental shift in market opinion. These occur when the market judges a stock has past the price threshold where it becomes a good buy. A bearish divergence is simply the opposite occurrence.
Trending markets work differently. In a market that is moving steadily upwards or downwards without the regular ranging motion, it is important to follow only the trend in all positions. The overbought and oversold indicators work the same way but with tightened values-60 and 40, respectively. In an up-trend, traders buy when the relative strength of the stock is below 40 but rising. In a down-trend, they short sell when the relative strength is above 60 and falling.
The Relative Strength Index is a powerful tool for day traders, as its potent indicators and signals help to reliably reinforce trading decisions. While day trading is far from a perfect science, the RSI can be an invaluable guide for beginners and trading veterans alike. While the indicators are not foolproof, they are great tools that logically support trades in a practice that can become dangerously emotional.
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