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When we are driving a bike or car or any kind of Vehicle, if any person want to go right or left side of the road, he/she will switch on indicator light of the vehicle that he is driving.
It gives us an indication that the vehicle is about to take a turning based on blinking of the indicator light.
But, one thing must be remembered that the vehicle may turn left side by giving the right side indication with the light.
However, the probability that the vehicle to take correct turn after giving indication will be high.
Imp Note : – We will take our driving decision while driving our vehicle based on the Indication given by the vehicle in front of us.
So, it is same with technical indicator for stocks/shares also.
Similar to Vehicle light Indicator or Traffic Light Indicators, Technical Indicators for stocks/shares also will give some indication about the trend(to go up or down) of the stock.
Before doing Investment in stocks with RSI, First, know about Line Chart…
Before understanding RSI indicator, you should first understand about the line chart of a stock/share.
What is Line Chart of a Stock/Share?
All of you know that in day a stock price will be traded in the stock exchange.
The price of the stock/share will fluctuate threw out the day.
For example, These days HDFC Bank share is trading around Rs.2,000.
This share in a move up to Rs.,2,100 or may move down to Rs.1,800 also ( It can go much higher or may come down much lower also).
Every day when the exchange closed for trading at 3:30 P M, the stock price will be closed at a price.
This price is Stock closing price for that day.
Moreover, HDFC Bank stock may close at Rs.2,100 in one day and may close at Rs.2,050 on the 2nd day, at Rs.2,150 on 3rd, and at Rs.2,200 on the 4th day.
If we put dots and draw a line across these closing prices of the HDFC stock/share, then that line will be called a Day chart of HDFC Bank Stock/share(as we have drawn the line across daily closing prices).
If you see above image B dot is much below than A dot as
Similarly, the other two dots C and D also reflect the 3rd and
If draw line across these dots A, B, C and D, then that line will be called as Hdfc Bank Stock price line chart.
The link chart will like as shown in the below chart.
If you see above line the price is down once and again it went up.
Just like the Traffic Light Indication or Vehicle signal Light Indication, we can use any Technical Indicator Indication to buy the stocks.
We can buy the stock/share.
There are so many Technical Indicators available to look at.
But, Relative Strength Index( RSI) is very important one.
The Typical line chart of any stock(share) will like the below image.
How to use Relative Strength Index Indicator for Investment in Stocks/shares?
J. Welles Wilder invented Relative Strength Indicator(RSI).
You can buy his book new concepts in Technical Analysis from this link.
To understand RSI indicator better first you should understand a example.
If we throw a cricket ball up and high towards sky, the ball will go higher and higher.
But the momentum of the ball will slow down gradually.
At one point will stay still for a while.
At this point the ball does not have upward momentum or down ward momentum.
Now, the ball will change its direction and will come down with momentum towards the earth.
As it completely lost its up ward momentum.
If see 1st arrow in the above image that is bigger than the 2nd arrow.
So, it is visible that upward momentum in 1st arrow is higher than the 2nd arrow in the image.
As the size of the arrows shrinking in the image means that upward momentum of the Cricket Ball is coming down.
Similar to the bigger arrows to small arrows shown in the above image helped us identifying the trend of
How the RSI Indicator can be used in buying stocks (Shares)?
The value of RSI will oscillate in between “0” and “100” always.
Look at the Pendulum image to understand better.
If you see the above image ball is not going above point C and point A.
The ball is changing its direction when it reaches points A and C.
Hence we can take a call that ball will come down when it reaches point C and Point A.
But sometimes we may go wrong too. The ball may go much higher crossing point B and C. But this probability of going high is much lesser.
Stock investing success is also depends on increasing the high probability.
Similar to plotting a Line across closing prices of a stock. We can draw(plot) a line across RSI values.
The typical RSI line chart also will like stock line chart. See the below image.
Does Stocks (Shares) Line will match RSI Line?…
Yes, Most of the times Line chart of Stock or share will be just line RSI line chart.
If you see above image, you can find RSI line has just similar look like the stock line chart.
This happened because RSI value follows stock price change and adjusts its RSI value according to the change in stock price.
If stock price forms lower lows in the line chart, RSI also forming lower lows and if the stock price forms a higher highs then the RSI value also forms higher highs.
How to Identify stocks (shares) Trend using RSI technical Indicator?…
Usually, RSI values also form higher high and and lower low if the stock forms higher and high and lower low as shown in the above image.
The above is showing only higher highs.
Relative Strength Index will give indication sometimes about the trend reversal.
We should compare RSI values with stock price on closing basis ( it can be daily or monthly or quarterly etc).
To understand this we need to understand Positive Divergence with RSI.
There are other kind of Divergences Negative Divergence, Hidden Positive Divergence and Hidden Negative Divergence with RSI.
But as we are talking about investment in stocks ( shares), Positive Divergence is important to understand.
When a stock is falling (price is going down), it will form lower lows, and the RSI also will form lower lows.
Hence, RSI line will look much similar to Stock Line Chart.
How to Know trend reversal of the falling stocks (Shares) with Positive Divergence or RSI?
You learned in this article that usually if stock will lower lows in down trend and RSI also will form lower lows just like shown in above images.
The stock falling may bounce back without forming positive divergence in RSI also.
But, if there is a positive divergence in RSI when compared to stock, then it is consider as strong indication that the stock is above to go up.
How to identify Divergence in RSI?
If you see above two images, you can find that stock which in down trend is formed lower lows from low 1 to low 3 (i.e low 3 value is lower than low 2 and low 2 value is lower than low 1).
But at the same time, RSI formed higher low from low 2 to low 3 (i.e low 3 value closed above low 2)
There are two conditions for Positive Divergence.
Stockshould form Lower low in it’sprices on closing basis in chart.
- Stock RSI values should form Higher Low on
When Positive divergence is formed the chances of that stock to get reversed from down trend and the price to increase from that level increases.
If see above image, in a Down Trend Bharat Finance changed its direction and the price went up after positive divergence formed in Daily Chart on 26-10-2018.
Do not jump straight away to buy a stock when you find a positive divergence. At which RSI value the positive Divergence formed also matters.
Now lets Understood at which RSI price levels one can buy stocks (shares)?
I have already said that RSI price will never go down below “0” and it will never go more than “100”.
So, Relative Strength Index Value will oscillate between 0 to 100 always.
Here, With respect to RSI price levels, we can identify the stock whether it is “Bullish Zone” or in “Bearish Zone”.
How to identify the stocks (shares) Bullish zone with the help of RSI?
- When a stock RSI value closes above 70, that means that the stock entered into a Bullish Zone.
- A stock which is in the bullish zone, its RSI value should not close below 40. If the stock’s RSI value closes below value 40, then that stock’s Bullish Trend is over, the stock is assumed that it entered in Bearish Zone( you can keep a cushion for RSI value up to 35).
- RSI above 80 is overbought and RSI value 40 to 45 is oversold for a stock which is in Bearish Zone.
- But do remember RSI value for Bearish Zone Stock (i.e overbought) doesn’t mean that we should sell the stock.
- Here, we should not buy fresh stocks at this RSI value of around 80. The stock once touches the RSI value of 80 also can move much higher further. At RSI value 75 to 80, it’s better to book major profits in the stock and should look for the small correction in the stock so that we will get the opportunity to buy again at RSI value around 40 to 50 with some indication to buy. The indication may be in the form of positive divergence or any other indicator which says its time to buy.
- Just Like the Trafic Light or Vehicle signal Light Example, RSI values of stock gives a signal about the stock is in the Bullish Zone overbought(RSI 80) and Oversold (RSI 40).
- A Stock is said to be in Bearish Zone if the stock’s RSI value is in the range of around 60 and 20.
Now lets look at some charts to Identify stocks (shares) entered in Bullish Zone…
In the above image, Axis Bank from Bearish zone it went to Bullish Zone ( i.e went above RSI 70), and now it is in a correction and stock is falling down.
RSI value of Axis Bank at present is around 60, we should wait for a buying opportunity in Axis Bank around RSI value 40 to 50.
In above image, HDFC Bank went into bearish zone on 24-092018. Since then it is unable to go into bearish zone.
We should not think of buying it until it’s RSI value touches more than 70.
If you see above image, Jubliant Food once entered in bullish zone is bouncing from RSI Levels around 35 to 40 levels when there is correction in the stock.
How to find buying Opportunity at RSI value 40 to 50 for stocks (shares) which are in Bullish Zone?
When a stock is in Bullish Zone, we can buy that stock if it’s RSI value is around 40 to 50, and some Technical Indicators are giving indications to buy the stock.
The indicators may be RSI positive divergence ( which we already learned in this articles) or Morning Stat Candle, Hammer Candle and Bullish Marubozu Candle.
Few more Precautions while buying stocks (shares) using RSI Technical Indicator are…
- But do remember, a vehicle after giving Right Signal also may turn left. But this probability is very low.
- Similarly, RSI values also give some indication of the momentum and trend. But doesn’t mean it definitely happen.
- You should always remember, in your investments, you will not get 100% stock calls right.
- But By doing some research with Technical Indicators, you can increase your success Probability significantly.
- Stock investing involves selecting a high probability of stock picking.
- Do not invest more than 2% of your investable surplus in a single stock.
- Always follow risk tolerance and goal oriented investment.
- Not only the RSI Indicator which we learned in this article, look at other fundamentals of the stock so that your chances will increase identifying the right stock.
- Given a score to each parameter and try to invest in a stock which got the high score.
- Your overall stock portfolio should not cross 10% of your total overall portfolio.
- If you have 1,00,000 to invest in stocks, then invest this 1 lakh in fixed income like liquid funds and wait for the opportunity to buy stocks using RSI bullish zone strategy. When you got a stock to buy then buy it with Rs.2,000 only ( as our we will buy 2% to 3% only for single stock).
Sell this stock at RSI value 70 and again wait for buying opportunity at
RSI value around 40 to 50.