The relative strength index (RSI) is a momentum indicator used in technical analysis, and it measures the recent price changes to evaluate if a particular share is overbought or oversold. It's often plotted as an oscillator beneath the graph of a share's price and can have a value from 0 to 100.
How can I use RSI when I invest in stocks?
- You can use it as a buy or sell signal. Usually, values of 70 or above are seen as signs that a security is becoming overvalued and may soon start a trend reversal or corrective pullback in price, potentially indicating a sell signal. An RSI value of 30 or lower indicates an undervalued situation, potentially giving a buy signal.
- While RSI is useful for identifying trend reversals, proper reversal signals are rare and can be challenging to differentiate from false ones. A false positive will be when prices hit above the 30% mark, which would suggest a buy signal but instead of rising, the stock price suddenly declines. A false negative, on the other hand, will be when prices hit below the 70% mark, which would suggest a sell signal but instead of falling, the stock price suddenly rises. Furthermore, prices may stay overbought or oversold for a long time when the stock has significant momentum, like the recent bull run after the March crash, which saw prices kept rising even though it was already overbought a few months ago. Thus, RSI is most useful when analyzing a share that is continuously alternating between bullish and bearish movements.
Debt to Equity Ratio
Used to evaluate a company's financial leverage and is calculated by dividing a company's total liabilities by its shareholder equity.
Profit is the financial benefit realized when revenue from a business is higher than the costs and taxes involved in operating that business.
Alternative investment class composed of funds that invest directly in private companies or that buy public companies and take them private
Time of declining economic activity, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and sales.
A stimulus package is a coordinated effort by the government to increase spending and investment to "stimulate" an economy out of a downturn.
Shorting a stock
Trading strategy that tries to take advantage of the decline in a stock price by borrowing a stock and sell it now while planning to repurchase it later for a lower price.
Market-capitalization-weighted index tracking the performance of the 500 largest U.S. companies