Indicator for an option
This is because the RSI is a momentum indicator, and indicates overbought price is too high and oversold price is too low conditions.
The Top Technical Indicators for Options Trading
In overbought conditions, the price of the stock is bound to retreat and stabilize in the near future. Similarly with oversold conditions. Whereas moving averages are based on a stock's closing price, the RSI is based on gains and losses.
Basically, the number and size of gains and losses are used to calculate the relative strength for a particular period, say a Day period. Subsequent relative strengths are then used to plot the RSI chart.
The RSI is an oscillating indicator, fluctuating between 0 andindicator for an option 0 is the most oversold, and is the most overbought. Anything above 70 is considered overbought, and anything below 30 is considered oversold. These levels will confirm overbought or oversold conditions much better, but are less sensitive to normal price movements.
For example, a stock in a trading range might never hit the 80 or 20 levels, and we will miss out on all signals. While the RSI can tell us when a stock is overbought or oversold, its true value is its ability to indicate when the stock is coming out of overbought or oversold conditions, i.
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So the points to watch are those when the RSI moves below 70 from above, or moves above 30 from below. It also crossed above 30 in May.
But before I get to volatility I want to discuss the indicator I use for my high-probability options strategies. I often asked by readers what indicators I use, so…here you go.
Therefore, we would implement bearish strategies in March and June, and bullish strategies in May. This is due to the fact that the RSI, being a momentum indicator, is a leading indicator and can predict price movement before it happens. However, this might not be a good thing, as can be seen in March.
The RSI produced a bearish signal a month before the actual downturn happened. In the world of options trading, a month is a long time.
It is used to indicate when a stock comes off its overbought or oversold conditions. A stock is overbought at RSI values above 70, and oversold at values below A positive divergence is when the RSI makes valleys or troughs that get higher and higher, and indicates a potential upturn. A negative divergence is when the RSI creates peaks that become gradually lower, and indicator for an option a potential downturn.
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For example, in the chart below, the RSI formed a negative divergence in January This is despite the fact that the actual stock price was making higher peaks. Sure enough, the negative divergence correctly predicted a sharp price drop in early February.
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- The Average Directional Index is an indicator that measures the strength of a trend.
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If we extrapolate further, we can see that after January, the RSI was forming lower and lower peaks all the way till June. This is a very bearish sign.
We have only touched on a few of the basic techniques involving RSI. There are other methods of reading RSI charts, and are beyond the scope of this guide. We have to mention again that individual indicators should not be used on their own, but rather with one or two additional indicators of different types, in order to confirm any signals and prevent false alarms.
This article focuses on a few important technical indicators popular among options traders. Also, please note that this article assumes familiarity with options terminology and calculations involved in technical indicators.
A positive divergence predicts future upturns, while a negative divergence predcits future downturns. Other Topics in this Guide.