What You Should Know about Relative Strength and Penny Stocks - dummies

What You Should Know about Relative Strength and Penny Stocks

By Peter Leeds

The relative strength index (RSI) can help investors by providing buy and sell signals, which are based on whether the underlying penny stock shares are in an overbought or oversold position.

Overbought refers to any stock that has increased in price beyond its appropriate value and so is due to come back down. Oversold refers to shares that are trading well below their appropriate value and are due for an increase in price.

Whether shares are overbought or oversold is very subjective, and the tools and criteria vary from one investor to the next and one stock to the next.

RSI is displayed in the lower portion of the trading chart. It is represented by a line that oscillates between 0 and 100. Generally, when the line breaks above a value of 70, the shares are considered overbought, indicating that lower stock prices may come soon. When the RSI line slips below a value of 30, the shares are considered oversold and have a high likelihood of trading higher.

While no technical analysis (TA) technique is accurate in all instances, history shows that overbought stocks have higher likelihoods of declining in price, while oversold stocks represent good value and are most likely to increase going forward. This makes a simple TA tool, like relative strength, very valuable and effective for investors.