Using RSI SMA strategies in stock trading

Technical indicators can be very helpful when analysing stocks, as they assist in identifying potential entry and exit points. Let’s look at how two popular indicators, the Relative Strenght Index (RSI) and simple moving averages (SMAs) can work together to improve your trading decisions.

‍

Understanding the technical indicators

‍

What is Relative Strength Index?

RSI measures whether a stock is overbought or oversold, which can signal a potential price reversal. It ranges from 0 to 100.

• Overbought (above 70): The stock may be too expensive and could fall soon
• Oversold (below 30): The stock may be undervalued and could rise soon

Typical setting: RSI is usually set to a 14-day period, but this can be adjusted to suit different strategies.

‍

What are Simple Moving Averages?

‍

SMAs calculate the average price over a set period, smoothing out short-term fluctuations to identify the overall trend. Two popular SMAs are:

• 50-day SMA: This represents the short-term trend
• 200-day SMA: This represents the long-term trend

‍

Simple Moving Average crossover

When the shorter-term SMA crosses above the longer-term SMA, it signals a bullish trend (often called a "golden cross"). Conversely, when the shorter-term SMA crosses below the longer-term SMA, it signals a bearish trend (known as a "death cross").

‍

Why use RSI and SMA together?

‍

Using both RSI and moving averages together helps confirm trends and reversals:

• RSI tells you if a stock is overbought or oversold, hinting at possible price changes
• SMA crossovers show you the direction of the trend (whether it's up or down)

‍

Together, these indicators give a clearer view of whether the stock price is likely to keep falling or change direction, helping you decide when to enter or exit trades. For example, if the RSI shows a stock is oversold and the 50-day SMA crosses above the 200-day SMA, this could be a strong signal to buy. 

‍

Why are RSI and SMA useful for stock trading?

‍

Earnings season

‍

During earnings season, stocks often experience sharp price movements based on company reports. RSI and moving averages can help you spot opportunities when these big price shifts happen.

‍

• RSI can help identify when a stock is overbought or oversold following earnings
• SMA crossovers can signal whether a price movement is the start of a new trend or just a temporary spike

‍

Market correction

‍

Many stocks may become oversold during a market-wide correction. RSI can help identify if a stock has fallen too far, while SMA crossovers can confirm whether the stock will likely continue the downtrend or start recovering.

‍

Relative Strength Index and Simple Moving Average crossover strategy: Entry criteria

‍

Bullish setup:

• RSI: RSI nears oversold region (30)
• Crossover: The 50-day SMA crosses above the 200-day SMA

‍

Bearish setup:

• RSI: RSI nears overbought region (70)
• Crossover: The 50-day SMA crosses below the 200-day SMA

‍

RSI and SMA crossover example: Amazon (AMZN)

‍

In the chart below of Amazon (AMZN), we see the 50-day MA crossing above the 200-day MA, signalling a bullish trend, while the RSI moves closer to oversold territory. According to the strategy, this combination suggests a buy signal.

‍

Risk management in stock trading

‍

• Stop loss placement:
  • In volatile periods (like earnings), use wider stops (e.g. 2-3% below entry)
  • In normal trading conditions, use tighter stops (e.g. 1-1.5% below entry)
  • Always consider the stock's Average True Range (ATR) when setting your stop loss

‍

• Profit targets:
  • For short-term trades, target when RSI approaches 70 (overbought) or when the SMA cross shows signs of reversal
  • For longer-term positions, scale out when RSI reaches extreme levels, while holding the core position as long as the 50-day SMA remains above the 200-day SMA

‍

Important considerations for stock trading

‍

When using RSI and moving averages for stock analysis:

• Use multiple time frames (e.g., daily charts for trends, hourly charts for entries)
• Maintain discipline: Stick to your strategy, keep position sizes consistent, and document your trades for review

‍

Market context

‍

Always consider the broader market conditions:

• The overall market trend (e.g. the direction of the stock indices)
• Sector performance
• Stock market volatility

‍

Stock-specific factors

‍

Before trading a stock, check:

• Earnings dates
• Ex-dividend dates
• Market capitalisation (which impacts price movements)
• Average daily volume

‍

Practice your RSI and SMA stock strategy today

‍

RSI and SMA indicators are valuable tools for confirming price trends and potential reversals, but they should be used as part of a broader analysis that includes both technical and fundamental factors. To refine your approach and build confidence, consider opening a free demo trading account at Deriv, where you can practice your strategy and make more informed trading decisions.