When to Use the Relative Strength Indicator?
In my book, fundamental analysis always trumps over technical analysis. That said, using both hand-in-hand is useful. After deciding that I like a company’s fundamentals, and that it can be bought at proper valuations, I like using technical analysis to help determine whether it is a good time to buy. Looking at the relative strength indicator or the RSI is a simple way to tell whether a stock is currently overbought or oversold. Investopedia defines RSI as “A technical momentum indicator that compares the magnitude of recent gains to recent losses in an attempt to determine overbought and oversold conditions of an asset.” When the RSI reaches 30 or under, the stock is considered oversold. When the RSI reaches 70, the stock is considered overbought.
RSI Example with Bed, Bath & Beyond
Just because the stock price reaches RSI 30, it could still keep going down. At the top of the Bed, Bath & Beyond (NYSE:BBBY) daily chart below, we see the RSI, indicating oversold for as long as month!
RSI Example with Union Pacific
On the contrary, a fundamentally strong company might seldom hit the RSI 30 area. Even when Union Pacific (NYSE:UNP) hit RSI 70 (became overbought), the price didn’t go down much, and only traded sideways for awhile. The sideways trading led the RSI to get back to 50, before the price went higher again.
I used to sell a company if it hits RSI 70. It maybe OK to do that if you’re trading. For a high quality company like Union Pacific, which is a part of my Dividend Income Portfolio’s core holding, I would only consider trimming or selling some of my shares if it becomes excessively overvalued, say 20% overvalued. Besides, going in and out of a stock can be stressful, as it means you need to track its price movement more frequently.
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Disclaimer: I am not a certified financial advisor. This article is for educational purposes, so consult a financial advisor and or tax professional if necessary before making any investment decisions.
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