What is RSI(Relative Strength Index) Indicator?
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What is RSI indicator?
Relative Strength Index (RSI) is a momentum-based oscillator developed by J. Welles Wilder Jr. in his seminal 1978 book New Concepts of Technical Trading Systems introduce.
It is a leading indicator that is now considered one of the cores and fundamental tools used by technical analysts around the world.
RSI is displayed as an oscillator (line graph) on a scale from 0 to 100. It is considered overbought when it is above 70 and oversold when it is below 30.
The purpose of the RSI indicator is to measure changes in price momentum and can be used to spot general trends. Additionally, the RSI can also be used to look for failure swings and divergences.
Calculation
RSI = 100 – 100/ (1 + RS)
RS = Average Gain of N Days Up / Average Loss of N Days Down
Note: The standard number of periods used to calculate the initial RSI value is 14, but you can change this value to reduce or increase sensitivity according to your needs.
Applied rules
As mentioned earlier, the RSI is a momentum-based oscillator. This means that as an oscillator, the indicator operates within a band or within a set number or parameter range. Specifically, the RSI operates on a scale of 0 to 100. The closer the RSI is to 0, the weaker the momentum of the price movement. on the contrary. The closer the RSI is to 100, the stronger the momentum for a period.
1. Overbought/Oversold
- When the price rises rapidly and thus has sufficient momentum, it will at some point be considered overbought and this may be a selling opportunity.
- When the price falls rapidly and therefore has low enough momentum, it will at some point be considered oversold, which can be a buying opportunity.
According to Wilder, any number above 70 should be considered overbought and any number below 30 should be considered oversold. RSI is neutral between 30 and 70, and RSI around 50 indicates “no trend”.
Some traders feel that Wilder’s overbought/oversold ranges are too wide and choose to change those ranges. This is entirely up to the trader.
2. Divergences
RSI divergences occur between the price action and the divergence shown by the RSI. These differences could be interpreted as an impending reversal. Specifically, there are two types of divergences, Bullish Divergence and Bearish Divergence.
- Bullish Divergence – When price makes a new low but the RSI makes a higher low.
- Bearish Divergence – When price makes a new high but RSI makes a lower high.
According to Wilder, Bullish Divergence creates buying opportunities, while Bearish Divergence creates selling opportunities.
3. Failure Swings
Failure swings are another situation that Wilder believes increases the likelihood of a price reversal. One thing to remember about failure swings is that they are completely independent of price and only depend on RSI. Failure swings consist of four “steps” that are considered Bullish Failure Swing(buying opportunities) or Bearish Failure Swing(selling opportunities).
- Bullish Failure Swing
- 1. RSI drops below 30 (considered oversold).
- 2. RSI bounces back above 30.
- 3. RSI pulls back but remains above 30 (remains above oversold)
- 4. RSI breaks out above its previous high.
- Bearish Failure Swing
- 1. RSI rises above 70 (considered overbought)
- 2. RSI drops back below 70
- 3. RSI rises slightly but remains below 70 (remains below overbought)
- 4. RSI drops lower than its previous low.
Summary:
The RSI indicator analyzes market buying and selling intentions and strengths by comparing the ratio between closing gains and total fluctuations over a period of time, so as to predict future market trends and reflect the degree of prosperity of the market in a certain period of time. The basic principle of RSI is that in a normal market, the strength of long and short must be balanced before the price will be stable.
RSI is used to measure the speed (velocity) and change (magnitude) of price directional movement. Essentially, the RSI, when charted, provides a visual means of monitoring the current and historical strengths and weaknesses of a particular market. Strengths or weaknesses are based on the closing price for a particular trading period, creating a reliable indicator of price and momentum changes. Given the popularity of cash-settled instruments (stock indexes) and leveraged financial products (the entire derivatives space), the RSI has proven to be a viable indicator of price movement.
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