Imagine you are driving a car, and you press the pedal to the metal. The car accelerates violently, but sooner or later you have to release the gas or shift gears so the engine does not overheat. RSI (Relative Strength Index) is the speedometer of the stock market. It tells you if a stock has been driving too fast and needs a break, or if it has crashed harder than it deserves.
"There is a balance in all things."
— Florence Scovel Shinn
RSI is measured on a scale from 0 to 100. This indicator helps investors find the balance and avoid buying when everyone else is euphoric, or selling when everyone else is in a panic.
Overbought and oversold
Magic limits: If RSI is over 70, the stock is called overbought. It has risen too quickly, and a downward correction is often near. If RSI is under 30, it is called oversold. People have sold in a panic, and the stock might be on sale.
How to use RSI
- Use RSI along with other tools. A stock can be overbought (over 70) for long periods if the company delivers great news.
- Look for divergence: If the stock price makes a new peak, but the RSI chart points downwards, it is a strong signal that the uptrend is nearing its end.