The relative strength index (RSI) aims to signal whether a market is considered to be overbought or oversold in relation to recent price levels. The RSI is an oscillator that calculates average price gains and losses over a given period of time. The default time period is 14 periods with values bounded from 0 to 100. A reading above 70 suggests an overbought condition, while a reading below 30 is considered oversold, with both potentially signaling a top is forming, or vice versa (a bottom is forming).
The moving average convergence divergence (MACD) is another trend-following momentum indicator that shows the relationship between two moving averages of a security’s price. The MACD is calculated by subtracting the 26-period exponential moving average (EMA) from the 12-period EMA. The result of that calculation is the MACD line.
A nine-day EMA of the MACD, called the signal line, is then plotted on top of the MACD line. It can function as a trigger for buy and sell signals. Traders may buy the security when the MACD crosses above its signal line and sell, or short, the security when the MACD crosses below the signal line.
The MACD lines, however, do not have concrete overbought/oversold levels like the RSI and other oscillator studies. Rather, they function on a relative basis. That’s to say an investor or trader should focus on the level and direction of the MACD/signal lines compared with preceding price movements in the security at hand, as shown below.
MACD measures the relationship between two EMAs, while the RSI measures price change in relation to recent price highs and lows. These two indicators are often used together to give analysts a more complete technical picture of a market.
These indicators both measure momentum in a market, but because they measure different factors, they sometimes give contrary indications. For example, the RSI may show a reading above 70 (overbought) for a sustained period of time, indicating a market is overextended to the buy side in relation to recent prices, while the MACD indicates that the market is still increasing in buying momentum. Either indicator may signal an upcoming trend change by showing divergence from price (price continues higher while the indicator turns lower, or vice versa).
Sources:
-Investopedia, Relative Strength Index (RSI) Indicator Explained With Formula, accessed 27 December 2023, <https://www.investopedia.com/terms/r/rsi.asp>
-Investopedia, MACD Indicator Explained, with Formula, Examples, and Limitations, accessed 27 December 2023, <https://www.investopedia.com/terms/m/macd.asp>