Relative Strength Index (RSI)

Developed by J. Welles Wilder, RSI measures the speed and magnitude of recent price changes to evaluate overbought or oversold conditions. It oscillates between 0 and 100.

RSI Trading Rules

  • Overbought: RSI above 70 suggests the asset may be overvalued
  • Oversold: RSI below 30 suggests the asset may be undervalued
  • Centerline: RSI at 50 indicates balanced momentum
  • Default period: 14 (can be adjusted for sensitivity)

RSI Divergence

One of the most powerful RSI signals is divergence—when price and RSI move in opposite directions:

  • Bullish divergence: Price makes lower low, RSI makes higher low → potential reversal up
  • Bearish divergence: Price makes higher high, RSI makes lower high → potential reversal down

MACD (Moving Average Convergence Divergence)

Developed by Gerald Appel, MACD shows the relationship between two exponential moving averages. It's both a trend-following and momentum indicator.

MACD Components
MACD Line = 12-period EMA - 26-period EMA
Signal Line = 9-period EMA of MACD Line
Histogram = MACD Line - Signal Line

MACD Trading Signals

  • Signal line crossover: Buy when MACD crosses above signal line; sell when it crosses below
  • Zero line crossover: MACD crossing above zero = bullish; below zero = bearish
  • Divergence: Similar to RSI divergence for reversal signals

Bollinger Bands

Created by John Bollinger, these bands measure volatility and provide relative price levels:

  • Middle Band: 20-period simple moving average
  • Upper Band: Middle band + (2 × standard deviation)
  • Lower Band: Middle band - (2 × standard deviation)

Bollinger Band Trading

  • Band squeeze: Narrow bands indicate low volatility, often preceding a breakout
  • Band touch: Price touching upper/lower band may indicate overbought/oversold
  • Band walk: In strong trends, price can "walk" along a band

Combining Indicators

Using multiple indicators together can reduce false signals. A common approach:

  • MACD: Identifies trend direction and momentum
  • RSI: Confirms overbought/oversold timing
  • Bollinger Bands: Provides volatility context
Research Shows

Pairing RSI with MACD has been shown to reduce false signals by up to 65% compared to using MACD alone. Multiple indicator confirmation improves trading accuracy by approximately 23%.

Limitations of Oscillators

  • Lagging nature: All indicators are based on historical data
  • Range-bound effectiveness: Work best in ranging markets; less reliable in strong trends
  • False signals: No indicator is perfect—always use stop losses
  • Over-optimization: Tweaking parameters to fit past data leads to overfitting

Put Your Knowledge Into Practice

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