- The relative strength index (RSI) provides short-term buy and sell signals.
- Low RSI levels (below 30) generate buy signals. High RSI levels (above 70) generate sell signals.
- The S&P 500's RSI is approaching a short-term sell signal.
The S&P 500 breached 3,000 for the first time ever back in July. After some choppy trading in the latter half of the summer, it has reclaimed that record—and then some, hitting new all-time highs in recent weeks. A combination of optimism for some kind of US-China trade deal, sufficient US corporate earnings growth, and more easy money actions from the Federal Reserve have helped the stock market reach new heights.
If you make shorter-term trades (i.e., trades that you plan to close within days, weeks, or months) in your portfolio, the relative strength index indicator suggests stocks may soon generate a sell signal. Here's what RSI says about US stocks now.
What is RSI?
RSI in context
Among the many technical tools that you can use to complement your analysis of stocks and other investment opportunities is RSI, which measures the speed and change of price movements. It is intended to evaluate the relative value of a stock, index, or other investment—based on its recent price history. Among technical indicators, RSI is one of the more commonly used due to the relatively simple, straightforward signals that it generates.
RSI is a momentum oscillator, a type of technical indicator that fluctuates in a range, usually from 0 to 100. RSI is used primarily to determine whether an investment is overbought or oversold. It is calculated using the average gain and average loss over a defined period of time (see the full formula).
Like other oscillators, RSI is most helpful in non-trending markets. A non-trending market exists when a stock, index, or other investment's price is fluctuating in a range between 2 prices. Non-trending markets might be identified by a broad market index, such as the S&P 500, failing to reach new highs or lows over a period of time—such as several weeks or months. While stocks have broken out to new all-time highs in recent weeks, the chart below shows how—until the last several weeks—the S&P 500 traded between 2,840 and 3,025 over the past 6 months.
In the chart above, RSI is the blue line beneath the S&P 500 price. Investors using RSI generally stick to a couple of simple rules. First, low RSI levels, typically below 30, indicate oversold conditions—generating a potential buy signal. Conversely, high RSI levels, typically above 70, indicate overbought conditions—generating a potential sell signal.
Some users of RSI and other indicators adjust the rules based on their own preferences and analysis. Instead of using 30 and 70 as oversold and overbought levels, one common modification that you might employ is to widen the parameters to 20 and 80. Here, if RSI were to drop to 20, that would generate a buy signal. Alternatively, if RSI were to rise to 80, this would generate a sell signal.
Trading signals generated by RSI are generally thought to be most valid when values reach an extreme reading near the upper or lower end of the boundaries. Thus, an RSI reading near 100 (the top of the RSI scale) would be greater evidence of overbought conditions (a sell signal), while an RSI reading near 0 (the bottom of the RSI scale) would suggest oversold conditions (a buy signal).
What RSI says about stocks now
Looking at the chart above of the S&P 500® Index, you can see that large-cap stocks are on pace for strong gains in 2019. However, RSI for the S&P 500 is currently near 70, suggesting a short-term sell signal. The last signal generated by RSI—a buy signal back in early August when RSI dropped below 30—preceded the 9% gain stocks have made since then.
It is important to recognize that, in addition to trading signals being considered more significant when RSI reaches extreme readings near 100 and 0, trading signals are also given more credence when the reading rises above 70 and stays above that level for an extended period of time, or drops below 30 and stays below that level for an extended period of time.
It is worth noting as well that RSI can remain in overbought or oversold territory for an extended period of time (weeks or even months). That is, if RSI were to eventually move above 70 or below 30, it would not be uncommon for it to remain above or below those levels for some period of time without retreating back to neutral territory.
In addition to the overbought and oversold signals that RSI can generate, it is possible to dig a little deeper into the relationship between RSI and the price action of the stock or index.
A positive reversal, for example, might occur when RSI makes a lower low (a relative low point on the chart that is below the most recent previous low) but the price is starting to make a higher low (a relative low on the chart that is higher than the most recent previous low). This would be a bullish move, generating a buy signal. A negative reversal could occur when RSI forms a higher high, but the price forms a lower high. This would be a bearish move, generating a sell signal. The S&P 500 has not recently exhibited a positive or negative reversal.
RSI in action
Basing trading decisions solely on any one indicator could result in poor analysis. Most technical analysts use RSI in conjunction with other technical indicators, fundamental analysis, and business cycle analysis. Consider using multiple indicators along with RSI, such as support and resistance, moving averages, and moving average convergence-divergence (MACD), to confirm the signals sent by RSI. That way, you'll have more evidence to support your analysis, potentially resulting in better trades.
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