The RSI and Why It Matters

One of the fist things you will learn in any finance class is that the RSI, or Relative Strength Index is your friend when it comes to evaluating the stock market on the whole.  The RSI is a ratio, or comparison between the high closing value of "x" number of days and the low closing value of "x" number of days of the stock market or particular stock or index.  The RSI attempts to determine when and identify where an overbought or oversold condition exists, or more simply, when the stock market has been over inflated or is under inflated.  This information is useful to investors because it allows them a small glimpse into the mechanics of a market and can be used for just one week or compared over a large amount of time like a year or longer.

While the RSI is a handy tool when it is used as a stock analysis package, it should be remembered that if a stock or index's value suddenly shifts up or down, it's tough to really use the RSI on its own to analyze the values until the measurements are allowed some time to average out over time.  That's why it's best to use the RSI as a trading tool, not an all out deciding factor.

As of right now, with the most recent bull market that has been with us since mid March, the RSI is indicating that the DJIA is entering the overbought region.  Given this and other indicators, an investor might be able to surmise that the DJIA is about to hit a bear streak due to many factors.  An RSI over 65 or 70 usually indicates an overbought status, while an RSI value of 30 or less indicates oversold.

During most stocks' up trends, the RSI will help to show the certain support level that the stock value will want to return to.  Anything above the support value and there is likely to be profit taking by investors that will return the value back to the support line.  The opposite is true if the stock value dips; investors will buy due to the oversold situation and the support price will once again appear.  It is often very hard to establish primary and secondary support values for most stocks and it takes more than just as RSI analysis to establish them.

When used with other tools and analysis software and formulas, the RSI has been a great indicator in helping millions of investors determine when to buy or sell and when to expect a drop or gain in a stock's price.  It goes without saying that the RSI is just a piece of the puzzle, and it really helps if you have other information handy like stock support levels when making a buy or sell decision.  Currently the RSI is predicting the DJIA to fall quite a bit over the short and mid term, and it will be very interesting to see if this holds true, giving the RSI that much more credibility as a market analysis tool.