Mastering Oscillators: RSI and MACD for Effective Technical Analysis

When it comes to effective technical analysis, mastering oscillators such as the Relative Strength Index (RSI) and Moving Average Convergence Divergence (MACD) is essential.

Mastering Oscillators: RSI and MACD for Effective Technical Analysis

Relative Strength Index (RSI)

RSI belongs to the group of oscillators that have both a midline and boundaries. It has two statistical boundaries, 30 and 70, in addition to the mathematical limits of 0 and 100.

Just like RSI, other oscillators can be used in multiple ways:

  • Overbought and Oversold conditions: These are considered extreme situations. When a stock's RSI is above 70, it indicates that it has experienced a significant upward movement in the past 14 days and is in an overbought state. This extreme condition suggests a possibility of a correction. On the other hand, when a stock's RSI is below 30, it indicates that it has experienced a significant downward movement, and from a technical perspective, a correction can be expected. Many individuals seeking quick solutions use RSI in this way. However, there are two reasons to avoid this approach:
  • Oscillators should be analyzed together with the price chart. The intention is not to use the RSI as mentioned above, but rather, when the stock is in an upward trend and the RSI is also rising, it confirms the trend. When the RSI reaches the 70 zone, it indicates a state of caution, suggesting that the stock may be approaching an exhaustion point. If there are significant positions, it implies not waiting until the end but starting to exit. In other words, the decision to exit depends on the size of the position.

According to Wilder, the actual signal comes after the divergence, which means when the indicator reaches a point and reverses. It is preferable for the indicator to cross the point and decline below it. This applies to both crossing the 70 line and the 30 line.

  • Divergence phenomenon: Divergence occurs when a stock rises and the RSI, when the stock reaches a new high, fails to surpass its previous high. Instead, it diverges downward from the stock. This is an early indication of a trend change. Although the stock shows a new high, the RSI indicates that statistically, within the past 14 days, it is much weaker. This implies a weak high, which may not be apparent on the chart but is visible on the oscillator.
  • Using the oscillator according to the stock's characteristics: Each stock has its own behavior patterns. Some stocks work well with the 30 level, while others work less effectively with the 70 level. It is necessary to examine the stock's track record in relation to the indicator, check at the 30 level or, for example, the 40 level, and adjust the appropriate oscillator levels for each stock.
  • Using RSI for trend identification: In classical literature, oscillators are considered trading indicators rather than trend identification tools. However, it is also possible to use oscillators for trend identification. For example, if there is a very strong upward trend, observe the RSI. If it drops, let's say to 50 or 40 instead of 30, and then starts rising again, it indicates that the RSI is trading in the range of 40-80 or 50-80. If the RSI drops below this range, it suggests a trend change. Similarly, if the RSI drops to, let's say, 30, it could be a buying opportunity, but with caution, as the purchase goes against the downward trend.
  • RSI at the beginning of a new trend: At the start of a new trend, the RSI often exhibits extraordinary strength. It can reach extreme levels that persist for an extended period, such as one to four months. Therefore, it is not advisable to use oscillators at the beginning of a new trend. However, in a consolidating stock, oscillators can be excellent tools.

Moving Average Convergence Divergence (MACD)

The MACD indicator calculates the difference between two exponential moving averages (EMAs): a 12-day EMA and a 26-day EMA. If the MACD is positive, it means that the shorter 12-day average is higher, indicating an upward trend in the medium term. If the MACD is negative, it means that the shorter average is lower than the longer average, indicating a downward trend.

MACD is an indicator that helps filter out noise and track trends conveniently. It is also a leading indicator. As long as the stock is declining and the MACD is declining, it means that the shorter average is moving away from the longer average, indicating a weakening trend. When the averages converge, it means that the shorter average is approaching the longer average, indicating an imminent trend change.

Signal Line

The signal line is a 9-day EMA calculated on the MACD itself. This line helps determine whether the MACD's trend has changed or not. If the signal line crosses the MACD, it indicates a trend change.
The distance between the MACD and its moving average has significance. It shows whether the trend is accelerating or decelerating, and the small green lines represent the distance between the MACD and its moving average. The MACD visually helps analyze the distance between the averages, and the green lines visually help analyze the distance between the MACD and its 9-day moving average.