Here's what
Welles Wilder has to say about using RSI:
"One
of the most useful tools employed by many technicians
is the momentum oscillator. The momentum oscillator
measures the velocity of directional price movement.
When the price moves up very rapidly, at some point
it is considered overbought; when it moves down
very rapidly, at some point it is considered to
be oversold. In either case, a reaction or reversal
is imminent. The slope of the momentum oscillator
is directly proportional to the velocity of the
move. The distance travelled up or down by the momentum
oscillator is proportional to the magnitude of the
move."
Wilder indicates
five factors in interpreting RSI alongside price:
- Tops and bottoms:
When RSI goes above 70 or below 30. RSI usually
tops out or bottoms out before the actual market,
giving an indication of imminent reversal, or
at least reaction.
- Chart formations:
Patterns, including tops or bottoms, triangles
and trendline breaks.
- Failure swings:
when the RSI goes above 70 or below 30 but fails
to exceed the previous high or low.
- Support and Resistance:
support levels in RSI are often analogous to
those on the price chart.
- Divergence:
divergence between price action and the RSI
is a very strong indicator of market turning
points.
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