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A Reminder and Example About the Short-term Nature of RSI

I thought this is a good example because it illustrates how the RSI (Relative Strength Index) is a very short-term indicator and, in addition, reminds of the rule that “the market can stay overbought or oversold for longer than you can stay solvent”.

It may be seen from the daily chart of the stock of Home Depot, Inc. that since last October there was a relatively smooth and strong uptrend from the $35 area to well above $50. That is a gain in excess of 40% when the majority of uninformed speculators and other types of recreational traders and gamblers were struggling with the volatile moves of some over-hyped stocks.

One important lesson from the above chart is that the RSI is a very short-term indicator for very fast traders who use it in conjunction with other indicators. Some investors and longer-term traders may at times get confused when they read analysis claiming that a certain stock is overbought. Such statements have nothing to do with the medium to longer-term prospects of the stock in most cases but some analysts are not careful enough to qualify their statements, maybe thinking that everyone is supposed to be an expert with the alchemy of technical analysis.

On the HD chart it is shown how the RSI(14) managed to jump above the 70% level that is considered the start of the overbought territory and did that several times after minor short-term corrections along the uptrend.  Thus the lesson is that any references to relative strength, RSI and related indicators, are useful to very short-term trades and have nothing to do with the longer-term prospects of a stock. This is something that experienced traders know but maybe not everyone who is reading this blog so I thought of clarifying this for this latter group while I am asking for the patience of the former group.

Disclosure: no relevant positions.

Charting program: Amibroker (Charts created with AmiBroker – advanced charting and technical analysis software. http://www.amibroker.com/”)

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