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Relative strength index (RSI) is a momentum indicator developed to compare the magnitude of recent gains and losses over a specified time period to measure speed and change of price movements of a counter. It is primarily used to attempt to identify overbought or oversold conditions.
Traditional interpretation and usage of the RSI is that RSI values of 70 or above indicate that a security is becoming overbought or overvalued, and therefore may be primed for a trend reversal or corrective pullback in price. On the other side of RSI values, an RSI reading of 30 or below is commonly interpreted as indicating an oversold or undervalued condition that may signal a trend change or corrective price reversal to the upside.
Caution to be taken when applying this strategy:
1. Most of the stocks that are in strong uptrend can have RSI above 70 for an extended period. It is therefore required to check whether there are any selling signals generated, eg: bearish divergence. Bearish divergence occurs when stock price makes a new high but the RSI does not. Support and trendlines should also be checked to determine whether it is the time to exit the market.