What is the Relative Strength Index (RSI)?

 

The Relative Strength Index (RSI) is one of the most popular technical indicators for assessing whether a market is oversold or overbought. Or to put it another way, whether the market is looking cheap or expensive.

The RSI is a momentum oscillator that measures the size and speed of price movements. A higher RSI reading equates to the security being overbought, while a low reading suggests it’s oversold.

Introduction to the Relative Strength Index

 

The RSI is determined by measuring the average gain for each period during the time frame, versus the average loss of each period where the security has fallen.

It is usually calculated over 14 periods (the standard number recommended by creator J. Welles Wilder).

The RS is determined by dividing the average gain of the up periods by the average loss during down periods.

RS = Average gain/Average loss

Average gain = Sum of total gains over 14 periods/14

Average loss = Sum of total losses over 14 period/14

The next step is to take the average gains and losses over the last 13 periods + the current period and then divide by 14. (this acts to make the oscillator more accurate as time progresses).

To get the RSI we simply take 100 and subtract 100/1+RS.

The RSI oscillates between 0 and 100. A reading below 30 indicates the security is oversold, while a reading above 70 suggests it is overbought.

RSI example:

1)

Average gain 10

Average loss 5

RS= 2

RSI = 100 minus (100/1+2)

= 100 minus 33.333

= 66.666 (neutral, but close to being overbought)

2)

Average gain: 14

Average loss: 1

RS = 14

RSI = 100 minus (100/1+14)

= 100 minus 15

= 86 (overbought)

Thankfully you don’t really have to understand the mechanics as it’s simple to add an RSI indicator to any chart on the TraderPro platform.

 

How to use the Relative Strength Index

 

In the TraderPro platform, open the chart of the market you are trading or examining. Use the ‘Studies’ button on the top navigation bar of the chart to find Relative Strength Index. When you click on this you will be greeted with a pop-up window inviting you to set the parameters of the RIS for your chart.

Wall_street_RSI_daily_14_Howto

Period – set the time periods – 14 is advised but it may depend on the time horizon you are trading.

Apply – You can use this to choose which price the RSI is based on – the open, close, high or low of the period. (Note for the example below for Wall Street we are using a daily chart and the close price, which offers the most reliable source of pricing for this particular market.)

Tram lines – This helps you see easily when the market was overbought or oversold. Simply set these are where you think overbought or oversold should be. Sticking to 70 and 30 is probably safest, but it’s up to you.

Click ‘Close’ and the oscillator will appear underneath the chart.


Wall_street_RSI_Jan_daily_14


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