The Relative Strength Index (RSI)

The Relative Strength Index (RSI)

Submitted by adil on Tue, 04/30/2013 - 07:04

All options traders require extensive use of indicators and signals. This enables them make decisions on what position they should take in the market, how they should trade and when they should trade. RSI is one of the foremost indicators that is used by traders in the realms of technical analysis. The RSI is basically a ‘momentum oscillator that measures the speed and change of price movements’. J. Welles Wilder developed it in a book published by him in 1978.

The RSI is drawn typically at a 14 day timeframe and measured on a scale of 0 to 100. When outlook is required for a different period, shorter or longer timeframe is used. The indicator compares the recent gains in price of an asset to recent losses. This is an attempt to measure overbought or oversold conditions of an asset. It is described as RS, that is, average of X days with up closes divided by average of X days with down closes.

For each trading period in the timeframe, the upward and downward change is calculated. Up period are characterized by the close being higher than the previous close. Similarly, a down period is characterized by close being lower than the previous close. If the there is no change, the up and down elements are stated as zero. These up and down elements are averaged using an ‘n-period exponential moving average’ (EMA).

The RSI is presented in the form of a chart, where values range from 0 to 100. When RSI for an asset reaches the 70 level, it is accepted as an indicator for asset being overvalued, giving a trader the signal that he should pullback from the asset. On the other hand if the RSI reaches 30 level, it signifies that an asset may have been oversold and undervalued. Extreme highs and lows are also used such as 80 to 20 or 90 to 100 which indicates stronger momentums.

The graph of RSI has more to it than meets the eye. The gradient of RSI is directly proportional to the velocity of a change in the trend. The distance traveled by the RSI is proportional to the magnitude of the move. Wilder also believed that divergence between price action and RSI is a very strong indicator that a market may be turning around very soon. It must be borne in mind that RSI is best used as a valuable complement to other stock-picking tools.

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