Figure 1: Example of using RSI in a sideway market

RSI In Trending Market

In cases where the price of the stock is trending upward or downward, the overbought and oversold levels have to be changed. This is because RSI being an oscillator that oscillates between 0 and 100 will stay high in an up-trending market as there are consistently more days where prices go up as compared to days when prices go down. Conversely in a down-trending market, we expect RSI to stay at low values. Using the same values of 70 for overbought level and 30 for oversold level will mostly result in wrong signals such as entering and exiting too early or no signal. Such a scenario is illustrated in Figure 2 where RSI did not even drop below the 30-level as Capitaland trended strongly from $2.80 all the way to $5.00. In this case, using the 30-level did not generate any entry signal for a long position. Moreover keeping the 70-level causes Capitaland to be in overbought condition for long periods of time.

Moving upward both the overbought and oversold levels to 80 and 40 respectively as illustrated in Figure 3 now provides clearer trading opportunities. In such up-trending stocks, notice that the oversold signals actually provide opportunities to enter for a long position during the short-term downtrend (retracement) in the longer uptrend price movement.

On the other hand, for RSI trading opportunities for down-trending stocks, the overbought and oversold levels have to be shifted downward to 60 and 20 respectively.

The examples of setting different overbought and oversold levels for different market conditions highlight the importance for technical analysis practitioners to adapt their use of technical indicators and indicator settings for different market conditions.