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Relative Strength Index RSI: Indicator, Formula and Calculation

relative strength index definition

Those investors are much more interested in the fundamentals of a company. While many traders will also look to ensure the fundamentals of the securities they’re buying are strong, their time horizon is generally shorter. A 2017 study found a buy-and-hold strategy is better over the long term than timing the market using RSI alone. The OBOS trading strategy suggests that you look for trend pivot points, which occur when the market becomes overheated and there is an imbalance of buy or sell orders. When the RSI line goes above 70, it’s considered overbought, and you should avoid buying the asset. Conversely, when the RSI line goes below 30, it’s considered oversold, and you should avoid selling the asset.

relative strength index definition

This means that the RSI indicator line should mostly move between the support and resistance levels of 40 and 60. Cardwell’s trend confirmation happens when the price rebounds from these levels. This strategy involves looking for bullish or bearish divergences between the RSI line and the price chart. A bullish divergence occurs when the asset price makes new lows, but the RSI indicator makes higher lows. This indicates that the downtrend may be losing momentum, and a reversal could occur. The RSI was developed by J Welles Wilder Jr as a momentum oscillator to measure the rate of change of price movements over a specific period.

How the Relative Strength Index is Calculated

Chart 7 shows Research in Motion (RIMM) with 10-day RSI forming a bullish failure swing. This approach can help traders plan their strategies, identify entry and exit points, and gain a competitive edge in the market. Markets aren’t that predictable, and each asset moves differently. While RSI is a powerful tool, it is much more reliable in a ranging market.

relative strength index definition

Such a formation is considered a bearish sign and, therefore, a sell signal for traders. Another price-RSI relationship that traders look for is positive and negative RSI reversals. Positive and negative reversals are the opposite of bearish and bullish divergences.

BUY Signals

If the RSI is above 70, the stock may be overbought, indicating that it may be due for a price correction. Conversely, if the RSI is below 30, the stock may be oversold, indicating that it may be due for a price increase. If we assume a 14-day period, a RSI with zero value would mean that prices moved lower in all 14 periods. This means that there are no gains to measure and the RSI by default has a value of zero.

To guide their trades, traders use a variety of analysis tools – like averages, oscillators, and indicators – to help them understand how an asset or market is performing. It is also frequently watched for divergence signals of possible upcoming trend changes. Moving average convergence divergence (MACD) and RSI are both popular technical indicators used by traders, but they serve different purposes. Moving average convergence divergence is better suited for identifying trend changes and momentum shifts, while RSI is better for identifying overbought and oversold conditions. By default, the RSI’s overbought conditions and oversold levels are set to 70 and 30, respectively. When the RSI line goes beyond these levels, it means the market is in an extreme condition.

Where have you heard about the relative strength index?

The typical period for determining the RSI is 14 days, but some investors may use a shorter or longer period to spot trends. The Relative Strength Index (RSI) is a momentum oscillator used to gauge the current overbought or oversold condition of a financial instrument on a scale of 0 to 100. Prices are considered oversold when the RSI falls under 30 and overbought when RSI rises above the 70. This strategy involves drawing horizontal and diagonal levels based on the oscillator reference points. These levels help you identify potential breakout points in advance.

How do you calculate relative strength index?

  1. RSI = 100 – 100 / ( 1 + RS )
  2. RS = Relative Strength = AvgU / AvgD.
  3. AvgU = average of all up moves in the last N price bars.
  4. AvgD = average of all down moves in the last N price bars.
  5. N = the period of RSI.
  6. There are 3 different commonly used methods for the exact calculation of AvgU and AvgD (see details below)

RSI indicator can also be used to predict a divergence in the trend before the price trend actually reverses. The deal here is to correctly identify if the breakout is sustainable for a long relative strength index definition period or a false signal. You can see in the graph below that the RSI indicator crossed the overbought zone in July 2018 and since then, the price continued to rise indicating a bull run.

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