How do you know if a stock is cheap or expensive? There are many tools that you can use to evaluate an investment opportunity. For example, you could look at the stock price in the context of earnings. If you like chart analysis, you could use a technical indicator called the Relative Strength Index (RSI).
Technical indicators, like RSI, are one tool used by chart analysts. Fidelity believes that earnings and other fundamental metrics of a business drive stock returns over time. Technical indicators may give you an idea of when you might want to buy or sell, based on the trading behavior of other investors.
How does RSI work?
The Relative Strength Index is an oscillator. It swings back and forth between upper and lower boundaries and may show you if a stock is overbought or oversold. RSI ranges between 0 and 100. According to most chart analysts, RSI levels over 70 point to an overbought situation, which could signal “sell,” while an RSI level under 30 shows that the stock may be oversold, maybe signaling “buy.”
Those levels are guidelines—not hard and fast rules. For some securities, you might prefer to adjust up or down if the stock you’re watching keeps bumping around 70 or 30.
RSI can also indicate trends. When RSI makes higher highs and higher lows, or lower lows and lower highs, it can signal a trend forming.
How to use RSI
Here’s the formula you can use for calculating RSI:
RSI = 100 – [100 / (1 + (Average of Upward Price Change / Average of Downward Price Change ) ) ]
The period used to calculate the price changes is typically 14 days, but this can be lowered to increase the sensitivity or raised to decrease the sensitivity to daily price movements. It’s not that complicated, but don’t worry—you won’t need to do any math to use RSI.
You can add RSI to your charts in Fidelity’s brokerage trading platform, Active Trader Pro® by opening a chart and clicking Indicators on the main menu. Find RSI and click on it to add it to your chart. From Fidelity.com, on the stock snapshot page, open the Indicators menu over the chart and select RSI.
Past performance is no guarantee of future results.
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