The RSI is used mainly to tell if a stock is overbought(has been bought heavily recently and is likely to pullback) or oversold(has been sold heavily recently and is likely to rebound). It can also signal when to enter or exit a stock which is what we will mainly use it for. We don't really care if a stock is overbought or oversold. Our main concern is when will it move and by how much. Stocks can stay overbought or oversold for very long periods of time. When the internet bubble popped many people were left holding companies like Lucent technologies thinking that they would rebound some day. On July 9 of 2000, Lucent closed at 64.00 dollars. It proceeded to sell off for the rest of the entire year and the following two years. At one point it was trading under a dollar. The point is that Lucent was oversold for 8 years.
Any stock can remain oversold for long periods of time. We don't want to buy a stock and wait for the rest of our lives to make a profit. So it doesn't matter if a stock is overbought or oversold. We want to know when the stock will move so that we can make a profit on it as quickly as possible and move on to the next stock. The RSI can tell us when to enter or exit a stock. When the RSI crosses above 50 the stock will move up and when it crosses below 50 the stock will move down. It sounds simple but it really is just that simple. The following are a few examples but you should check as many stocks as possible to see for yourself what happens when the RSI crosses 50 in either direction.
The chart above is a very good example of what happens when the RSI moves above and below 50. At point A the RSI crosses above 50 and the price of AAPL skyrockets from around $70.00 in July of 2006 to around $200.00 in December of 2007. During that time period the RSI never went below 50. When it dropped below 50 in September of 2008 the price dropped from above 150 to below 100. You can click the charts to enlarge them.
Note: The cross below 50 in January was not overlooked. The crosses at A and B were chosen strictly for their illustrative purposes.
The chart above is a 20 year chart of Ford. Points A and B further illustrate what happens to the price of a stock when the RSI crosses 50.
