Moving averages and the Relative Strength Index (RSI) are two of the most widely used tools in technical analysis. They appear by default in almost every charting platform, and they are often the first indicators new traders learn. This guide explains how each one works, how traders commonly interpret them, and – just as important – their limitations.
If you are completely new to charts, start with our beginner’s guide to technical analysis.
Part 1: Moving Averages
What is a moving average?
A moving average smooths out price data by calculating the average price over a set number of periods, updated with each new period. On a daily chart, a 50-day moving average is the average closing price of the last 50 trading days. As each new day is added, the oldest day drops off – so the average “moves.”
The purpose is to reduce day-to-day noise and make the underlying trend easier to see.
SMA vs. EMA
- Simple Moving Average (SMA): every price in the period has equal weight.
- Exponential Moving Average (EMA): recent prices get more weight, so the EMA reacts faster to new price moves.
The trade-off is simple: faster averages respond quickly but produce more false signals; slower averages are smoother but lag behind turning points.
Common periods
| Period | Often used for |
|---|---|
| 20 (or 21) | Short-term trend |
| 50 | Medium-term trend |
| 200 | Long-term trend; widely watched by institutions and media |
How traders commonly use moving averages
- Trend direction: price above a rising moving average is often seen as an uptrend; price below a falling one as a downtrend.
- Dynamic support and resistance: in trending markets, price sometimes pulls back to a moving average before continuing.
- Crossovers: when a shorter average crosses above a longer one, some traders view it as bullish. The 50-day crossing above the 200-day is popularly called a “golden cross,” and the reverse a “death cross.”
Limitations
Moving averages are lagging indicators – they are built from past prices, so they confirm trends after they begin rather than predicting them. In sideways, choppy markets, price may cross back and forth over the average repeatedly, producing a string of misleading signals often called “whipsaws.”
Part 2: The Relative Strength Index (RSI)
What is RSI?
The RSI is a momentum oscillator developed by J. Welles Wilder and introduced in 1978. It compares the size of recent gains with the size of recent losses over a set period – most commonly 14 periods – and expresses the result on a scale from 0 to 100.
In simple terms, when recent up-moves have been much larger than down-moves, RSI rises toward 100. When down-moves dominate, it falls toward 0.
Overbought and oversold levels
- Above 70: traditionally considered “overbought” – the price has risen quickly.
- Below 30: traditionally considered “oversold” – the price has fallen quickly.
- Around 50: a neutral midline; some traders use it to gauge whether momentum is broadly positive or negative.
A crucial point: “overbought” does not mean “about to fall,” and “oversold” does not mean “about to rise.” In a strong trend, RSI can stay above 70 or below 30 for a long time. Many traders therefore treat these levels as a sign of strong momentum rather than as automatic reversal signals.
Divergence
A divergence occurs when price and RSI move in different directions. For example, if price makes a new high but RSI makes a lower high, some traders read it as fading momentum (a “bearish divergence”). The opposite pattern at lows is a “bullish divergence.” Divergences can persist for a while before anything happens – or fail entirely.
Using Moving Averages and RSI Together
Because moving averages describe trend and RSI describes momentum, some traders combine them. A common approach is to use a long moving average to define the overall trend, then use RSI to look for pullbacks within that trend. For instance, in an uptrend (price above the 200-day average), a trader might watch for RSI to dip toward 40–50 and then turn up, rather than waiting for a deeply “oversold” reading that may never come.
This is one example of how indicators can be combined – not a strategy recommendation. Any approach should be tested on historical data and paired with clear risk management rules, such as predetermined position sizes and exit points.
Common Mistakes to Avoid
- Using default settings without understanding them. Know what period your indicator uses and why.
- Treating indicators as predictions. They summarize past price behavior; they do not know the future.
- Stacking too many indicators. Many indicators are built from the same price data and simply repeat each other.
- Ignoring the bigger picture. News, earnings, and broad market conditions can overwhelm any technical signal.
- Skipping risk control. A good-looking setup can still fail; how much you risk matters more than any single signal.
Key Takeaways
- Moving averages smooth price data to show trend; EMAs react faster than SMAs.
- RSI measures momentum on a 0–100 scale; 70 and 30 are traditional overbought and oversold levels.
- Both are based on past prices and can give false signals, especially in choppy markets.
- Indicators work best as part of a tested plan with clear risk limits – never as standalone buy or sell commands.
Important Disclaimer
The information in this article is for general educational purposes only and does not constitute financial, investment, tax, or legal advice. All investing involves risk, including the possible loss of principal. Examples are simplified illustrations, not predictions. Consider consulting a qualified professional before making financial decisions. See our full Disclaimer.
