Relative Strength Index
The definition for Relative Strength Index – RSI
It is a tool that is used to determining the magnitude of changes in price, which are relevantly recent. The purpose is to evaluate whether the stocks or assets have been oversold or overbought, keeping in view the conditions of the price. It is drafted as an oscillator, which is a line graph moving between extremes. It can provide an analyst with a reading ranging between 0 to 100. J. Welles Wilder Jr. developed the Relative Strength Index in 1978. This is an ideal index for determining the price movement across bulls and bears.
In this article we will :
Learn about Relative Strength Index formula, how to calculate relative strength index.
Learn about advantages of using relative strength index indicator.
• What is RSI ? It is one of the major momentum oscillators.
• J. Welles Wilder Jr. developed it in 1978.
• It compares the price movement of bulls and bears
• It has a graph plotted the price of assets
• It ranges from 0 to 100
Relative Strength Index formula calculation
The formula for calculating RSI (RSI calculation) is:
RSI =100 – [100/ (1+ (AVG Gain/AVG Loss))]
The average percentage of loss or gain or a look back phase is used in the above calculations. In the case of average loss, positive values are used in this formula. For calculations of the initial value of RSI 14, periods of phases are used. For instance, if the average gain of the course of 7 days out of the 14 days was 1%, and the remaining 7 days it was a loss of 0.7%, the calculation would look like:
RSI =100 – [100/(1+(1%/14/0.8%/14))]
The second step of the calculation can be done once RSI is calculated in the first step.
RSI =100 – [100/ (1+(Previous AVG Gain x 13 + Current Gain/ Previous AVG Loss x 13 + Current Loss))]
The above formula can be used to calculate RSI so that the data can be used to plot a graph with the prices of assets. As the number of positive clones, which are the average gains, increases so would the value of RSI. However, if the size of losses increases, the size of the RSI will also increase.
What RSI Tells You
The tool measures the speed at which price moves.RSI trading potential is huge. The rate of fluctuating and vary from 0 to 100. To have a basic understanding of the index, any stock or asset that has a value of 70 or above on the oscillator is either being overbought or overvalued. As for a reading of 30 or below that, it shows that the asset or stock is either being undervalued or is being oversold. This is commonly used to understand whether this conditions of the market is that off overselling ours underselling. If the market is overextended, it will most probably retrace. To benefit from the indicators of RSI, a trading strategy of in today can be devised
To take advantage from indications get from RSI as a processing thing, an intraday Trading Strategy can be a device. Oversold means, an extended price moves to the downside and overbought means an extended price move to the upside. A reversal is possible when prices reach any of the extreme levels whether upper or lower. While RSI can be used to confirm the reversal if it is accurate or not. So, this helps to better understanding and accuracy of results in general.
Advantages of using Relative Strength Index indicator.
Do you have a better understanding of stocks or assets that either overbought on oversold it is beneficial to focus on the trading signals and those techniques which would conform to the trend in the market? To make it more simple, using bull signals in circumstances when the price is bullish, and using bear signals when the stock or price of an asset is in a bearish trend. This would benefit you to overcome any incorrect situation generated by RSI.
How to use Relative Strength Index Indicator ?
Do you understand the relative strength Index, Wilder stated that it is beneficial and necessary to understand the principles of this index. Price can only be considered overbought when it rapidly moves up. Similarly, when the price of the stock or an asset rapidly moves down, it is considered as oversold.
RSI measures the strength of trading stocks. The distance that RSI travels is proportional to the magnitude of the movement. As for the slope of RSI, it is directly proportional to the velocity at which the trend is changing.
If the relative strength Index is over the level of 70, it would be considered overbought. However, if the readings are below 30, it would be considered as oversold. At 50 level, there is no sign of any trend at all. On an average being between the range of 30 to 70, the trend would be considered neutral.
Can we draw trend line on it? Of course, trend line on this indicator is the best way to see trend reversal pattern.
If there is any divergence (rsi divergence image) between relative strength index and price action, then it is considered as a strong indication that there might be a forthcoming turning point in the market. When the price reaches a new level of high, but the relative strength Index makes a lower level of high, then there is a bearish divergence. However, when the price is at a new level of low, with the relative strength Index making a higher level of law, the divergence would be termed bullish. The graphs which are plotted make it very easy to understand when there is a bullish divergence RSI and when bearish divergence RSI in the reading.
Overbought and Oversold RSI Condition
Understand if a market is going through a reversal, the failure swings of the stock can be observed stock can be observed. These failure swings are either above 70 or below 30. For instance, assume that the RSI is at 82, but then falls back to 78, and then rises to the level of 84. In such a situation, if the RSI falls below 78, it would be considered as a “failure Swing” above 70. It is very important to understand when the condition is that of being oversold and overbought, as this would make it very easy for analyzing the data and determining what the RSI is indicating.
The RSI chart is ideal when it comes to understanding areas and formations of support and resistance, as compared to seeing them on a price chart. As already discussed at level 50 of the relative strength index there is no trend of observed at all; this is why it indicates a line of support and resistance at the same time. This level of the index shows that if the RSI drops below 50, they would be more losses than gains. However, if the RSI moves about 50, then there would be more gains than losses.
Bullish Swing Rejections
Another technique that is used to examine the behavior of the relative strength index is swing rejection. This technique is used when the relative strength index is emerging again from the oversold or overbought regions. This is a bullish technique, and it is four major components:
1. RSI has fallen into an area of oversold stocks
2. RSI has crossed the level of 30%
3. RSI falls back below the level of 30%, without it having moved into the territory of oversold.
4. It then bounces and breaks its highest level.
This method of using RSI is similar to the use of trend lines.
Bearish Swing Rejections
There is a bearish swing of rejection as well. It is a mirror image of what we just discussed above. It is a back and forth movement of the RSI in the overbought region. It also has four phases:
1. RSI has risen into the area of overbought stocks
2. RSI has crossed below the level of 70%
3. RSI moves back above the level of 70%, without it having crossed into the territory of overbought.
4. It then bounces and breaks its lowest level.
RSI vs. MACD
Relative strength index is not the only momentum indicator, which follows the trend. There is another such indicator as well called Moving Average Convergence Divergence. This indicator is used to depict the relationship between two average prices of security, which are moving. To calculate the MACD the exponential moving average of 26 periods is subtracted from that of 12 periods. This results in getting the value for the MACD line.
The Relative Strength Index is aimed at indicating and ensuring if the market at any particular point is oversold or overbought. This is done in relation to the price levels at that point. It also calculates the average losses or gains in the price over a specific time period. The time period used in these calculations by default is up to 14 periods, with the value ranging between zero to hundred.
The MACD is used to measure the relationship between EMAs, whereas the RSI is used for measuring the movement in price changes, with regards to the highs and lows of price points. Most of the time, these indicators are used simultaneously. This helps in providing traders and analysts with accurate information about the conditions of the market. These traders and analysts would be unable to make the right decision, without using both Relative Strength Index and Moving Average Convergence Divergence.
RSI and MACD both are used for measuring the momentum within any market. However, they do not measure the same factors. This is why at times their indications might be contradictory to one another. For instance, the MACD measurement of the market might indicate that the market is steadily increasing with regards to the momentum of buying. Whereas, RSI might indicate that the market has been overextended to the side of purchasing and buying, with a reading of above 70. This might make it difficult for traders in understanding what is accurate and which indicator should follow.
Limitations of Using RSI
This is an ideal tool, for comparing bearish and bullish price movement and it is used to display the results through, an oscillator, which can also be positioned along a price chart. For better result, it is necessary that it follows the long term trend. Finding and having true reversal signals is not an easy task; neither is separating it from any false alarms. A reading of a false negative might seem like a situation of a bearish movement, where their might have been a sudden upward acceleration of the stocks. As for a false positive, it would be something like a bullish movement followed by a rapid stock decline.
This indicator has the capacity to stay within the worst one or overboard regions for a very long period of time. This is mostly because it is pleasing movements of the price along with the asset, for as long as it remains strong. Thus, for RSI is accurate only when the price is moving between bearish and bullish territories.
1. How can RSI be determined in MetaTrader?
It is located within the indicator section in the group of oscillators. This would really make things easier.
2. Which level of RSI is considered good?
RSI only determines the strength of the index. A level below 30 or above 70, both can be deemed as strong and can generate profits in the future.
3. How would it be determined where to set the RSI?
It would be best to have a default setting. Majority of the traders all over the world use a setting, which is the same so that they would be able to make decisions on default parameters. Thus, it would best to have the setting on default.
4. What are some of the advantages and disadvantages?
It is a very simple and straight forward indicator. The downside to this, however, is that it is a very fast moving indicator, and most of the times, one would have to wait for some time before getting the price confirmation.
This is one of the best indicators of strength. It provides very accurate information to the traders, provided the data being used for calculating it is accurate as well. If it is not then there clearly would be issues with RSI that has been determined.