Finding a superstock with record gains is the holy grail for many investors. But often the opportunity to buy these stocks is at the start of a trend or on a pullback. Therefore, being able to differentiate between uptrends, pullbacks and downtrends is crucial. Momentum is one of the tools that can help us with that.
My favourite momentum indicator is the Relative strength index, or the RSI, which is the indicator that I will discuss in this article.
Background of the RSI
J. Welles Wilder Junior developed the RSI, which is described in his 1978 book, New Concepts in Technical Trading Systems. The RSI compares recent gains to recent losses and evaluates recent price magnitudes to find overbought and oversold conditions. It is an oscillator moving between two extremes, measuring the speed of price movements.
How it works
The RSI moves as a line between 0 and 100, underneath the price chart. A traditional strategy consists of finding overbought and oversold conditions through the RSI. Above 70 is generally considered to be overbought, and oversold is considered to be below 30. Nevertheless Andrew Cardwell, who developed the usage of the RSI even further, thinks that overbought and oversold conditions should be closer to 80 and 20, which he talks about in the video below.
Ways to use the RSI
Traders use the RSI in a multitude of ways. For example, it is used to find areas of support and resistance, spot turning points, confirm signals from other indicators, look for moving average crossovers on the RSI and use it on multiple time frames to find a successful trade.
Range shifts
One of Andrew Cardwell’s ideas is the concept of a range shift. The idea is that a security in an uptrend will normally oscillate between 80 and 40, while in a downtrend between 60 and 20. Therefore, in a Bull range, you should not only watch the number 40 on the downside, but also 60. Because if the price cannot get back over 60 after a pullback the trend might be getting tired and ready to reverse.
Momentum
Momentum is the rate at which an object changes speed. Therefore, if momentum is strong, you will often see the RSI hit above 70 and closer to a 100 on rallies. Furthermore, it will stay above oversold conditions on pullbacks. The strongest stocks will often stay above 40 on pullbacks during uptrends, and the strongest stocks will stay above 50, according to Certified Market Technician JC Parets.
Positive reversals
A positive reversal takes place when the RSI hits a lower low while the underlying asset reaches a higher low. This is a bullish sign and one of the leads that can help to spot a buypoint in a pullback. Conversely, a negative reversal takes place when the RSI reaches a higher high while the underlying security is reaching a lower high. Below is a positive reversal on the weekly chart for Bitcoin in 2024.
Another interesting example of a positive reversal taking place, when I write this in March of 2025, is in Tesla. Based on the positive reversal calculation the price target should be almost double that of today’s price at 400 + (100 – 22) = 478. Let’s follow Tesla’s stock in the coming years to see where it goes, and to see if the formula worked on this stock.
Positive reversal after a range shift
A positive reversal that comes after a range shift, or a positive divergence, is a bullish sign. A range shift happens when the price goes from a bear range into a bull range. Then the positive reversal helps to confirm the trend change and can act as an entry point on a pullback.
An example of this happened in Alibaba’s stock recently, which relates to my China article. Note how the RSI broke 60 on the upside at the shift over to year 2023. A clue to a possible longer-term trend change.
Notice that the positive reversal took place after a bullish divergence and a range shift that happened in 2024, indicating a trend change. The price target, based on Cardwell’s book, should be “Target + (Ref – x)”, or 116 + (80-72) = 124. According to Cardwell’s book, the trend is considered strong if the price target is exceeded. Hence, since Alibaba surpassed the price target of 124 to the upside, we can consider the upward momentum to be strong. Therefore, it will be interesting to follow this stock.
Breakout stocks
During a correction, a stock will often start to trade sideways, and in the very strongest stocks, you will not see the RSI trade below 30, in these bullish ranges, preceding the breakout. The RSI gives a clue that the stock is going to explode to the upside when it eventually breaks out. The strongest stocks will only go down to about 40. A few superstocks might even trade in the middle of the RSI range, closer to 50, before they explode to the upside.
In this video, JC Parets describes why overbought conditions are generally a good thing and how to find momentum:
RSI on multiple time frames
In the video JC Parets says that he wants to see an overwhelming amount of buyers. Therefore, the RSI should be in a bullish range both on the weekly and the daily time frames. Because this indicates a lot of buying pressure. The video has a very good example, of a breakout, where multiple time frames correlated. In the breakout of Tesla’s stock in 2013. During its consolidation phase in 2011-2012 it never went into oversold conditions on the RSI either on the monthly, weekly or daily. That was a sign that the stock would eventually explode.
Here is the original article where JC Parets describes how he incorporates momentum into his process and that he prefers it to remain in the 35-40 area during corrections in bull ranges.
How I use the RSI
I use a 14 period RSI on all of my time frames, where the weekly is the one that I track the most. Because I am mostly a long term position trader in stocks I follow the RSI to find spots to buy on pullbacks. But what I prefer the most is to find an asset at the beginning of a longer term uptrend. Ideally I want all the time frames to correlate and point in the same direction. The strongest securities have very high RSI readings before they break out. The RSI tools that I use the most are positive reversals, divergences alongside RSI range readings applied to formations and at the beginning of trends.
Stock analysis
The RSI can be used on all assets, not only stocks. But below I will show an example of a stock I analyzed, Stillfront. Stillfront was trading in a bullish range before it soared on November 27 of 2019. In my original analysis I wrote that the stock looked ready to soar which it eventually did. One of the clues was the strong RSI reading.
A warning
Finding momentum is one way to gauge the market and single out stocks, but it should not be used all on its own. Price action always trumps indicator behaviour and stop losses protects the downside. It is important to do due diligence and trade with caution.
Conclusion
The RSI is my favourite momentum indicator. There are many more indicators to gauge the market. But to confirm where the underlying trend is headed it is a good tool.
Stay posted for part 2 in my RSI series.
Disclaimer: All information found on this site, ideas, opinions, predictions, commentaries are for informational, entertainment or educational purposes only and should not be construed as personal investment advice. While the information provided is believed to be accurate, it may include errors or inaccuracies. I will not and cannot be held accountable for any actions you take as a result of what you read in here. Use the information at your own risk. I am not your investment advisor. Consult a licensed financial advisor before making any investment decisions.
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