Trend Trading with RSI (Relative Strength Index) Using RSI Support and Resistance
Originally published in 2009, this article has been updated.
There are many ways to use the RSI, with the most common methods being overbought/oversold levels and divergence with price. Today we are looking at a third way to use the indicator – trend trading with RSI using RSI support and resistance levels…which vary by uptrend or downtrend.
RSI (relative strength index) is an oscillator and commonly people believe that the RSI is only valuable when price is ranging. This is false. An oscillator can give us a lot of information about trends as well.
Trend Trading with RSI
The first thing we need to know is that the RSI moves within support and resistance channels during price trends. The levels the RSI ranges between can indicate the strength of the trend.
- In an uptrend the RSI range should stay between about 30 and 90+.
- In a down trend it will generally stay between 20 and 70 (often 60).
This can let us know if a trend is reversing, as a drop below the 30 level on an RSI is rare in an uptrend. If an uptrend ducks below 30 or fails to recover above 70, the uptrend has been stifled. These levels will vary slightly depending on the market traded, so find the levels your RSI ranges between before using this method of analysis on trends (if the market is ranging this information is not particularly useful).
In the chart above 30 acts as a support level for the uptrend, while it was breached for a day or two on a number of occasions the RSI quickly bounced and moved back up to the 80+ level, confirming the up trend was still in place.
This means if we are in an uptrend we will often have “overbought” type readings on the RSI. Many traders exit positions (or go short!) because they think a price reversal will materialize simply because the RSI is showing a reading of 90 for example. This is not necessarily the case. The RSI looks at average up moves and average down moves, therefore, the RSI can move out of overbought territory even without a significant fall in price. This is because even sideways movement can bring down the “up average” calculation of the RSI. This allows the RSI to fall to more normal levels, with price never really moving lower, but simply taking a breather.
It is true, a reversal will eventually occur, but the a trade should not be exited on the single premise that the instrument is “overbought.” Rather we need to look at other factors… is price actually breaking? Is the RSI range still showing strength by staying above 30 and hitting the 80+ range? Is the RSI making new highs as price makes new highs (this is good)?
Here is an example of trend trading with RSI when the trend is down. Notice how the price is continually reaching 20 on the RSI, and struggling to breach 70. Toward the right side of the chart the RSI definitively breaks above 70 and reaches near 90. This did end up being a turning point for the stock as the price didn’t reach the April low again (at least not as of March 6, 2014)
Just a few things to consider. Trend trading with RSI support and resistance levels can help confirm trends and isolate when the market is shifting direction.
As always, trust price the most though. Indicators are just interpretations of price data, so often the price itself will tell you all you need to know about which direction to trade in, and when to step aside when the trend is unclear.