The relative strength index (RSI) is a fairly reliable indicator that can tell you whether a stock or market is overbought or oversold. The RSI fluctuates between 0 and 100, although it hardly ever reaches either of those levels. You can choose the levels between 0 and 100 that you think indicate that a stock is overbought or oversold, but for the sake of analysis in this chapter, I use 30 as my oversold level and 70 as my overbought level. Therefore, RSI readings under 30 tell you that a bottom could be coming soon and that you should be ready to buy, and readings over 70 should lead you to consider putting on a short or selling a long. (For more of the nitty gritty details of the RSI, check out Chapter 11.)
The RSI has two potential uses when you’re working on candlestick analysis:
You can combine the information from an RSI with reversal patterns to further confirm that a reversal is imminent, and it’s time to take a long position.
You can also use the RSI to help you select your exit levels, whether they are stops to prevent losses or exits that allow you to walk away with a tidy profit.
In this section, Figure 12-1 provides a solid example of the type of situation ...