RSI beginner’s guide: how to identify overbought and oversold levels

The Relative Strength Indicator (RSI) is a widely used oscillator developed by J. Welles Wilder, known for its ability to detect potential trend changes across different time frames. Unlike many other indicators, the RSI provides timely insights, allowing traders to identify potential movements and shifts in trend earlier than traditional lagging indicators.

Properties of the RSI

a) Leading indicator: The RSI is considered an indicator ahead of the price curve, providing insights into potential market movements before they occur.

b) Strength and weakness detection: The RSI primarily detects the strength or weakness of the prevailing trend, offering a measure of the underlying momentum.

c) Overbought and oversold zones: The RSI oscillates between a range of 0 and 100, effectively delineating overbought and oversold conditions. Typically, readings above 70 indicate overbought levels, while readings below 30 suggest oversold conditions. Some traders may also use alternative thresholds such as 80-20 to define these zones.

When is a signal generated in the RSI?

It is important to consider the specific time frame being used on the chart, such as 5m, 15m, 30m, 1h, or daily. However, some believe that the 15-minute (15m), 30-minute (30m), and 1-hour (1h) time frames tend to produce the best trading signals.

For a buy or long signal, the price should exhibit a downtrend within the analysed time frame. At a certain point, the price should halt and coincide with the RSI reaching equal or lower levels of 30. This alignment suggests a possible rebound, although the specific price targets are unknown.

Conversely, for a sell or short signal, the price should be in an uptrend. It should eventually pause and coincide with the RSI reaching levels of 70 or higher.

Two conditions must always be met for both long and short signals: the price should come from a preceding uptrend or downtrend, and the RSI (with the price paused) should be above 70 or below 30.

Traders can employ various risk management techniques that suit their preferences when utilising this strategy. For more information, have a look at our introductory article on technical analysis and this trading guide.

How does RSI work in the short term or intraday?

When using the RSI in the short term or intraday, it is important to focus on time frames such as 15 minutes (15M), 30 minutes (30M), 1 hour (1H), or daily charts to enhance the reliability of the strategy and minimise false signals.

To implement the strategy, identify the last significant low for a long trade and the last significant high for a short trade as reference points. Set a stop-loss (SL) slightly above the high for a short trade and slightly below the low for a long trade to manage risk.

The most reliable signals are those above 70 and below 30, although sometimes they also work at very close levels to 70 and 30.

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Learn more about technical analysis

• Fibonacci sequence
• Elliott Wave theory
• Dow’s Theory
• MACD
• Bollinger bands
• Stochastic oscillator
• Trend indicators
• Support and resistance

RSI: summary

This strategy, as mentioned before, is straightforward and easy to comprehend, yet it often faces criticism from traders who expect better results from more complex strategies.

However, complexity does not necessarily lead to improved outcomes. Simplicity in trading strategies can often provide the correct answer, while our psychological biases and behaviours frequently pose significant challenges in the world of trading.

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