How to use RSI and MACD indicators

RSI (Relative Strength Index) and MACD (Moving Average Convergence Divergence) are two indicators used in Technical Analysis of charts, which are based on formulas that help investors predict a future trend in the price of a given financial instrument.

The RSI (Relative Strength Index) is a technical indicator used to evaluate market conditions in which the price of a given asset is in overbought or oversold.

This indicator is displayed as a graph of lines between the values of 0 and 100, and normally a reading below level 30 indicates an overbought condition and a reading above level 70 indicates that an asset is in overbought.

There are several ways to interpret this indicator being that, one of the most probably used is, on one hand, to consider a buy signal every time (having the RSI dropped below level 30) it crosses this value again in an upward trend and, on the other hand, to consider a sell signal every time (having the RSI exceeded the 70 value) it crosses this value again in a downward trend, as shown in the graph below.

Another interpretation of the indicator could be through a divergence where the price is on a downward trend while the RSI indicator line shows an upward trend.

This indicator may also indicate divergence, i.e. a downward trend is observed in the price of the asset, while the indicator line shows an upward trend, which may indicate that the price will reverse its direction, as shown in the graph below.

 

MACD (Moving Average Convergence Divergence) is another widely used indicator by investors and is determined by subtracting the 26-day exponential moving average (MACD line) from the 12-day exponential moving average, resulting in the 9-day exponential moving average of the MACD itself (also called the signal line).

The purpose of this indicator is then to identify important moments resulting from the convergence and divergence of these moving averages, which may have various interpretations.

The most commonly used interpretation is through crossings, i.e. whenever a MACD line crosses its signal line in an upward direction, then a buy signal is provided, on the other hand, whenever the opposite happens, a sell signal is indicated, as the chart below illustrates.

 

Another method would be through divergences, which occur whenever the MACD's own behavior diverges from the price of the underlying asset. That is, this happens when, for example, the MACD performs successive troughs and the value of the asset in question continues in an upward trend. When this happens, an inversion of the asset's price direction may occur which, in this particular case, may be interpreted as a sale signal. The inverse is also valid, however in this case, the result of this analysis may be interpreted as a sign of purchase. The graph below exemplifies this same interpretation.

 

Both indicators provide signs of market dynamics, however, they evaluate different factors, which can sometimes even give contradictory signals. This is why one should always take into account the market context and know how to analyze the main trend of the asset in question, to minimize the interpretation of false signals. In short, in order to maximize the gains in the market and potentialize the hit rate, it is essential to have a good combination of Technical Analysis with Fundamental Analysis and with the support of some indicators.