Relative Strength Index (RSI)
Definition:
Relative Strength Index (RSI), an oscillator introduced by J. Welles Wilder, Jr., could be more appropriately called the internal strength index, for it compares the price of a security relative to itself. The RSI is based upon the difference between the average of the closing price on up days vs. the average closing price on the down days over a given period, and is plotted on a vertical scale of 0 to 100. An oscillator refers to a momentum or rate-of-change indicator that is usually valued from -1 to +1 or 0% to %100. Wilder advocated a 14-day RSI, although shorter and longer periods have gained popularity when the market exhibits certain characteristics. Generally, RSI is measured in a period between 5 and 25.
RSI is most charting programs original method of displaying this indicator. Classic is the conventional calculation of the RSI indicator and is new with version 4.11. RSI is a value calculated with the following equation:
1
1 + U/D
1 + U/D
Where U is the average of upward movement and D is the average of downward movement. RSI Classic uses this calculation.
There are two formulaic differences between RSI Classic and RSI.
- Whereas RSI classic creates U by (total upward movement/number of up days) and creates D by (total upward movement/number of down days).
- RSI Classic uses an exponential moving average of (AvgGain/AvgLoss) where AvgGain = total gain in n periods. N is the rsi period.
Interpretation:
There are several possible interpretations for the Relative Strength Index, any of which can be very powerful depending on the market conditions and trading/investment approach: One interpretation is that buy signals are triggered when RSI is in oversold (20-30) area, potentially meaning that the stock is about to reach its low for this trend, and sell signals are triggered when RSI is in overbought (70-80) area, potentially signaling a market top. A second mode of interpretation is to look for support and resistance lines or common chart formations such as head and shoulders in the RSI itself, indicating potential reversals that the stock chart may not.
A third mode of interpretation is to recognize divergences in the RSI, such as when the price is moving up when the RSI is moving down or vice versa. This can mean that the price is going to "correct" and move in the direction of the RSI.
A fourth mode of interpretation for the RSI is to view it as a bullish or bearish signal when it crosses 50. When the RSI crosses above 50 it can be considered bullish, and when it crosses below 50 it can be considered bearish.
