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Relative Strength Index

Big Idea: Relative Strength Index or RSI is a good tool to measure whether or not price is overbought or oversold. An RSI scale will show a chart labeled 1-100, where 30 and below is oversold, and 70 and above is considered overbought. It works as a data average of whatever the time period is and measures the current price relative to the average of the previous prices. For example, a 14-day moving average measures the relative strength or weakness within those 14 days and places the current price on the scale from 1-100. If the point dips to 30, investors might want to look at buying. If the point comes up over 70, investors might look to sell.

CADJPY Example

This chart shows the price of CADJPY on the top and the 14-4 Hour Period Relative Strength Index on the bottom. As you can see, there are several points where the chart hits above or below the purple area. Anything within that zone is the “normal level” of where price could be. The part in gray represents where price is overbought or oversold. When price dipped to 30 on that first blue line, CADJPY entered into a short term uptrend. When the price rose to 70, the pair came back down.
This tool is very helpful in buy-the-dip or short-the-top opportunities, but they are not always correct. You can also see that those two overbought areas on the chart marked above 70 twice, but price continued to rise. Just as any trading tool, RSI should be used to estimate potential entries. In this instance, it would have been better to buy the dips rather than shorting when the pair moved too high according to the 14-Period RSI tool.

Key Takeaways

-RSI measures the relative strength or weakness of an individual pair/stock/crypto

-RSI is a tool that helps investors decide when something is overbought or oversold

-You can set an RSI period to any number of minutes, hours, days, etc.

-Sometimes, the trend (or other news/indicators) takes precedence over when price is overbought/oversold, so it’s not a guaranteed indicator

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