Relative Strength Index

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Relative Strength Index

The most widely followed momentum oscillator in technical analysis is J. Welles Wilder Jr's Relative Strength Index (RSI).

In it incorporated two major corrections for problems he had encountered when constructing momentum lines:

  • Smooth the effect of sudden price movements at the opposite end of the range from the current interval, and
  • Display the indicator in a constant range, facilitating comparisons between instruments

This popular momentum oscillator compares the magnitude of a stock's recent gains to the magnitude of its recent losses and then converts the result into a number that ranges from 0 to 100 for consistent charting.

The RSI calculation is a two step process:

rsiformula.png

* Note - It is important to remember that the Average days Up (Gain) and Average days Down (Loss) are not true averages, but are 'smoothed' averages that give slightly more importance to the most recent day in the range that is averaged (14 days is the default range). This is one of the corrections mentioned above.

Using the RSI

The Relative Strength Index compares the stock's (or market's) up intervals to its down intervals. That is, over the last specified number of intervals, how many of those finished with a closing price above the previous interval, and how many with a closing price below. The RSI usually looks at the last 14 days (Your SOFTWARE's default), but individual securities may yield better results with a shorter or longer period.

The indicator is indexed to run from 0 to 100 and usually moves (or oscillates) between the values of 25 and 75. However, on the rare occasions there have been a large number of up days in a row it will move between 75 and 100, indicating an overbought condition (a good time to sell). Occasionally it will also move to between 0 and 25, indicating an oversold condition (a good time to buy).

Limitations

The RSI is prone to many false indications, and there's nothing foolproof in its interpretation.

It is absolutely useless during a trend. For example, an up trend causes a continuously overbought indication, while a downtrend pushes it into permanent oversold mode.

On its own, the RSI's utility is questionable, but when combined with other techniques it comes into its own. It is especially useful for filtering out false signals generated by other indicators.

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