According to a study by Investtech, a technical analysis research firm, stocks with high RSI, above the critical 70 level, have continued to rise. Similarly stocks with low RSI, below the critical 30 level, have continued to underperform.
They studied 31,220 cases on daily charts where RSI(21) crossed above the 70 limit and 23,404 cases where RSI(21) fell below the 30 limit. They named this strategy “RSI momentum” where a buy signal occurred when RSI went above 70 and a sell signal when RSI fell below 30, quite the opposite of what the classical use of RSI suggests.
Investtech’s research shows that the "overbought/oversold" interpretation is not statistically correct. The results show that RSI is a good indicator of whether the stock has positive momentum or negative momentum and that this RSI momentum is a good indicator of future price movement.
Similar research into the performance of this indicator confirms their findings: An academic paper published in 2014 looked at the profitability of two RSI trading rules: The researchers found that the centreline crossover rule performed better than buying below 30 and selling above 70.
Momentum traders are therefore only interested in RSI levels 20 units or so above or below the mid-line or centre line at 50. Remember this because it’s critical to the development of the RSI Histo indicator.
In the image below, the classic RSI indicator has been altered to colour bars above 60 or below 40. The remaining bars are grey. As you can see, periods of high price momentum are nicely highlighted which offers the trader the ability to focus on trading setups in those zones. The RSI Histo indicator strips out the “unhelpful’ data between the 60 / 40 levels and focuses exclusively on the high price momentum periods outside of the 60 / 40 levels.
Closing thoughts on RSI
There are several important factors to consider when using the Relative Strength Index indicator, such as the settings, the score (30 and 70), and the bullish/bearish divergences. However, one should always keep in mind that no technical indicator is 100% efficient - especially if it is used alone. Therefore, traders should consider using the RSI indicator along with other indicators in order to avoid false signals.
Useful Stuff
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