In the past, we wrote about oscillators in trading, and today we want to supplement that post. In that article, we explained that the RSI is an oscillator that typically gives a buying signal when it reaches the value of 20 and a selling signal when it reaches 80.
However, we also said that if you trade according to these rules, you will likely lose money in the long-term. Is it because the oscillator is useless? Not at all. On the contrary, it is very useful, but the experienced trader will have much to say about the efficiency of its use.
What does the past have to say about the RSI in your specific stock?
When looking at the RSI, it is a good idea to check where it has stopped in the past. If you look closer at the RSI, you will find some stocks that have their own levels. When this happens, it does not make sense to follow the general rules of 20 and 80.
For example, when being in a downtrend, a stock’s RSI could fall beyond 20; and when making corrections to the falls, it may rise to 60 and then come back to the falls. This will not always happen, and you won’t find any stock that always follows the rules. But remember that what you need is a positive, long-term expectancy. In other words, win more money than you lose in the long-term, assuming that some trades will make you lose, and that is business cost.
Therefore, if you spot a stock with an RSI that typically goes to 20 and then rises to 60, it may be worth it to take a short position the next time it reaches 60. Actually, it can make more sense than doing it when it reaches 80 because 80 is a more extreme value, unlikely to be reached in a downtrend, and thus reaching it could mean that the stock is changing the trend.
When the stock is going up, it happens the same. Maybe on these occasions, it sometimes goes beyond 80 before starting the correction (so reaching 80 does not need to be a sell signal). On the other hand, when the correction starts, it usually does not reach 20, and it stops at 40 instead. This means that the stock is showing strength, and it may be a good opportunity to buy. Again, if you wait until the correction reaches 20, you will miss many opportunities; and once it reaches 20, it may mean that the trend is changing.
Conclusion
Instead of blindly trusting in the “official” levels, study the specific levels of the RSI in which the stock usually stops and changes the movement.
It is also a good idea to supplement your analysis with other indicators, especially taking into consideration resistances and supports. If you only look at one indicator and it works, it may be too good to be true in the long-term.
Remember that when trading with UK stocks, you do not need a medallion guarantee, but you will need it when selling or transferring shares listed on the US or Canadian stock markets.
*We do not give financial advice, and this blog post is only for entertainment purposes.