The RSI is one of the most popular Technical Indicators used today by traders and analysts to indicate oversold and overbought conditions in a market. Although it’s a widely used indicator, it is by no means faultless, and it doesn’t guarantee successful investment decisions by itself. Only a trader with deep knowledge of the market and the RSI itself could successfully use the indicator to advance their profits.
RSI is a great and reliable indicator to use in conjunction with other investment tools. It’s exceptionally reliable in longer timeframes, when deciding not to buy an asset, used in an oscillating market, and when you don’t limit the timetable.
There are certain situations when using the RSI indicator would yield better results. In this article, you’ll learn about the optimal conditions in which using the RSI would be most reliable, as well as about utilizing this tool in combination with other indicators.
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4 Situations Where RSI Gives Most Reliable Readings
The four situations in which RSI gives the most reliable readings are as follows:
When Conforming to Long-Term Trends
Although the RSI indicator can be used for day trading successfully by more experienced traders, for the average investor, its highest chances of succeeding occur when its signals conform to long-term trends.
Following this indicator, differentiating reversal signs from false positives or negatives can be difficult, therefore following it for a more extended period (take the recommended 14-days, for example) may increase your possibilities in making the right call.
Using RSI over a longer period may also allow you to identify more significant trends that might be difficult to pinpoint otherwise. The use of the indicator would be beneficial in this situation because of its ability to help identify potential entry and exit signs in a long-term environment where divergences are few and far between and stocks are in stable trends.
While it’s true that using the RSI indicator for a more extended period of time may produce fewer signals, therefore being inaccessible to swing and day traders, the signs that’ll be generated will be marginally more reliable. This approach would work very well on more unstable assets as well.
2. When Deciding Not To Buy an Asset
Going by the 30/70 rule when using RSI as a tool does allow you to make confident buying and selling decisions. Practically speaking, users have reported better results with the indicator using it to decide on which asset not to buy, rather than which one to buy.
The tool is fallible, even when used for longer periods, resulting in the production of false-positive and negative signals. And while these signals may lead you towards a wrong buying decision as the 0-30 level is relatively limited, a sudden move in the wrong direction may turn your investment from profitable to fruitless.
Meanwhile, when operating in the broader remainder of the spectrum, the level of which indicates when not to buy an asset, your probability of making a correct investment decision will increase.
3. In an Oscillating Market
The RSI indicator displays momentum, an asset’s general trend that can guide you in making the correct buying or selling decision. That said, when this momentum is significant, this trend can continue staying as overbought or oversold for a longer time than expected, diminishing your profits.
For this reason, the indicator would work best and yield the highest profits in a more variable environment, where the price of a specific asset constantly alternates between bearish and bullish movements for you to profit from this change in the asset’s market value.
4. When You Don’t Limit the Timetable
Although, as I said previously, the creator of the RSI indicator recommends a 14-day period in utilizing this tool, the only way to use it entirely to your advantage and increase your chances of making successful market decisions is to know how to tailor the timetable to your specific trading strategy.
Knowing how and when to shorten or expand this timeframe will make this tool more reliable, as it’ll function according to your own specific strategy and deliver quality information within the needed period.
The RSI in itself is generally used for relatively short periods of time, but expanding its window to weeks or even months can make it possible to use the indicator independently to compare short and long-term movements in the market. This would make the signals more reliable and decrease the number of false positives and false negatives.
Using RSI in Combination With Other Indicators
Although RSI is a reliable indicator, it’s not advised to be used by itself in making investment decisions, as it simply doesn’t provide all the information a trader would need before taking action upon an asset.
That’s why this tool is best utilized and most reliable when used in conjunction with other important indicators. The most commonly chosen indicator to use along with RSI is the MACD (moving average convergence divergence).
What this technical momentum indicator does is it can be used to confirm the validity of specific RSI signals. The MACD serves a similar purpose to the RSI but calculates momentum a little bit differently. Using the MACD, acceleration is calculated by comparing relative positions of a short-term and a long-term moving average.
Although they differ in how they measure momentum, both share a specific quality, in that they usually signal to buy when there is a lot of selling and, on the flip side, signal to sell when there’s a lot of buying. This way of trading goes against traditional investment approaches, but these indicators can deliver highly reliable information when used together.
To use these indicators in combination with one another, you need to compare their respective signals. If they both signal to buy an asset, this asset has a high chance of being oversold and vice versa, an overbought asset expecting a crash in price in the near future would be signaled by both indicators to be sold.
Another valuable way to increase the reliability of the Relative Strength Index is by using it in combination with EMA (exponential moving average). This indicator plays the same role as the previously mentioned MACD in confirming the validity of RSI’s entry and exit signals. This tool is a valuable addition to the longer-term RSI because it has a shorter response time to price changes, making it easier to detect possible diversions early.
For this reason, the shorter-term EMAs would be the best addition to the Relative Strength Index, giving you a more well-rounded point of view of the market before making a decision. The reason why this combination can be so valuable to an investor is that the EMA can smooth out the RSI indicator, making it more reliable and easier to read while decreasing false signals noticeably.
As shown, combining the Relative Strength Index with other reliable indicators, such as MACD or EMA, will increase each tool’s reliability, as together they create a more realistic view of the market and its trends.
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Conclusion
The RSI indicator is an accurate and reliable tool to use in conjunction with other indicators. Although it’s not advised to base your decisions on this tool by itself, it’s an excellent addition to the vast array of tools that traders can use to make better-informed decisions.
The RSI is most reliable when used over more extended periods of time, when used to decide against buying an asset, used in an oscillating market, or when you’re not limited within a timetable. Some of the most common indicators that are used along with RSI are the MACD and EMAs.
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