Relative Strength Index

By mosesbet · Filed Under Spread Betting Comments Off on Relative Strength Index 

The Relative Strength Index is a momentum oscillator (very similar to the Stochastic Indicator) which measures the velocity and magnitude of market price movements.  The Relative Strength Index (RSI%) was developed by J. Wilder in 1978 and published in his new book, “New Concepts in Technical Trading Systems”.

The RSI has increasingly become popular among traders because of its simplicity and  its ability to help traders find price reversals, failure swings and centre-line crossovers (used for support and resistance levels).

What is the Relative Strength Index?

The RSI is a momentum oscillator which means it measures the velocity and magnitude of market price movements.  The RSI usually takes into account the moving average of the previous 14 days of closing prices and compares them to historic prices to show whether a market is overbought or oversold.

The RSI data is presented on a scale of 1-100 underneath the chart.  If the RSI is over 70 than the market is considered overbought and the price should drop back down again.  If the RSI is under 30 than the market’s considered oversold (meaning there are more sellers than buyers) and the market should bounce back up again.  Other traders may use different RSI parameters (e.g. 10/90 or 20/80) for different reasonss however the 70/30 model is used 99% of the time.

The exact formula for the RSI is based on a ratio of higher closes to lower closes over the last 14 days.  The steepness of the curve represents the velocity of price changes while the height represents the magnitude of changes.

How to Use the RSI with Trading

Price Reversals: The RSI provides a number of advantages to traders.  First of all the RSI allows you to spot price reversals (also known as “failure swings” or a change in pattern) just like the Stochastic Oscillator.  If the RSI moves above 70 then you know it’s going to come back down again, allowing you to “short” the stock.  Alternatively if the RSI moves below 30 then it should bounce back up given that the market is oversold, allowing you to go long here.

Support/Resistance Levels: If you’re trying to find support and resistance levels than Wilder also stated that these can be found much more easily on the RSI chart as opposed to the price chart.  You can actually use the middle line (50) as both the support and resistance level.

Uptrends and Downtrends: Andrew Cardwell developed new interpretations of RSI to spot uptrends and downtrends.  He found that he was able to confirm upward or downward trends based on bearish or bullish divergence.  Divergence occurs when the market makes a new high and the RSI doesn’t confirm (i.e. market high is higher than RSI high) or when the market makes a new low and the RSI fails to confirm.



Be Sociable, Share!