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RSI – Relative Strength Index

RSI - Relative Strength Index

Relative Strength Index (RSI) is a technical analysis tool that is used by investors to make investment decisions. Developed by J. Welles Wilder, RSI is a momentum oscillator that helps in determining the rate of change of prices. RSI values range from 0 to 100. An RSI of 30 indicates that the asset is oversold while an RSI greater than 70 shows that the asset is in overbought position.

How Investors Use RSI to Make Decisions?

Investors generally look for divergences in the market prices which they can exploit to make profits. RSI helps in achieving this task. The tool can also be used to identify general price trends, centerline crossovers, and failure swings. This information can prove useful for investors in making wise investment choices.

RSI can be calculated using the formula given below.

RSI = 100 - 100 / (1 + RS)

where,

RS = Average of up closes during a specific period / Average of down closes during a specific period

RSI technical analysis tool compares the average price increases and average price decreases to determine position of the asset. This RSI is calculated for different periods including 5 days, 10 days, 14 days and more.

If the RSI of an asset is more than 70 (overbought), investors avoid buying the asset, and try to sell the asset if they already own one. On the other hand, if the asset's RSI is below 30 (oversold), investors buy the asset, and hold the asset if they already own one.

An overbought asset means that too many investors have bought the specific asset at a particular time. As a result the prices are likely to fall in the near future. On the contrary, an oversold asset is likely to increase in value in the near term as investors will likely purchase the asset at a bargain price.

The default period of calculating RSI values is 14 periods. However, investors can increase or decrease the number of periods for determining RSI values. Higher periods decrease the sensitivity of the RSI values to actual market prices while lower periods increase the sensitivity. The actual period that is selected for calculating depends on the type of assets. A 14 period RSI for a utility company, for instance, is less likely to become oversold or overbought than a retailer such as Amazon. Investors can adjust the periods based on the requirements of the security.

Apart from type of security, the investment horizon also determines the RSI period selected by the investor. Short term traders generally use 2-period RSI, while long term traders use 30 or more period RSI to make investment decisions.

Like many other technical analysis tools, RSI offers the best benefits when used along with other complementary tools such as Moving Averages (MA), Moving Average Convergence Divergence (MACD), Fibonacci Retracement, and Support and Resistance Levels.


Further Reading


Technical analysis and the London stock exchange: testing the MACD and RSI rules using the FT30
www.tandfonline.com [PDF]
… Note: The numbers marked with ∗∗ are significant at the 5% level for a two-tailed test. Table 2. The returns of the RSI rule … International Journal of Finance and Economics, 2: 319–31. [Crossref], [Web of Science ®], [Google Scholar]; Murphy, JJ 1999 …

Technical analysis and the Spanish stock exchange: testing the RSI, MACD, momentum and stochastic rules using Spanish market companiesTechnical analysis and the Spanish stock exchange: testing the RSI, MACD, momentum and stochastic rules using Spanish market companies
www.tandfonline.com [PDF]
… Note: The numbers marked with ∗∗ are significant at the 5% level for a two-tailed test. Table 2. The returns of the RSI rule … International Journal of Finance and Economics, 2: 319–31. [Crossref], [Web of Science ®], [Google Scholar]; Murphy, JJ 1999 …

A comparison of MA and RSI returns with exchange rate interventionA comparison of MA and RSI returns with exchange rate intervention
www.tandfonline.com [PDF]
… Note: The numbers marked with ∗∗ are significant at the 5% level for a two-tailed test. Table 2. The returns of the RSI rule … International Journal of Finance and Economics, 2: 319–31. [Crossref], [Web of Science ®], [Google Scholar]; Murphy, JJ 1999 …

CAST: Using neural networks to improve trading systems based on technical analysis by means of the RSI financial indicatorCAST: Using neural networks to improve trading systems based on technical analysis by means of the RSI financial indicator
www.sciencedirect.com [PDF]
… Note: The numbers marked with ∗∗ are significant at the 5% level for a two-tailed test. Table 2. The returns of the RSI rule … International Journal of Finance and Economics, 2: 319–31. [Crossref], [Web of Science ®], [Google Scholar]; Murphy, JJ 1999 …

THE BEST PARAMETER COMBINATIONS OF RSI <span style=[J]' src='/thumbnails/?img=http%3A%2F%2Fen.cnki.com.cn%2FArticle_en%2FCJFDTotal-JJSX200102002.htm' />THE BEST PARAMETER COMBINATIONS OF RSI [J]
en.cnki.com.cn [[J]' href='https:/api.miniature.io/pdf?url=en.cnki.com.cn%2FArticle_en%2FCJFDTotal-JJSX200102002.htm'>PDF]
… Note: The numbers marked with ∗∗ are significant at the 5% level for a two-tailed test. Table 2. The returns of the RSI rule … International Journal of Finance and Economics, 2: 319–31. [Crossref], [Web of Science ®], [Google Scholar]; Murphy, JJ 1999 …

Revisiting the Performance of MACD and RSI OscillatorsRevisiting the Performance of MACD and RSI Oscillators
www.mdpi.com [PDF]
… Note: The numbers marked with ∗∗ are significant at the 5% level for a two-tailed test. Table 2. The returns of the RSI rule … International Journal of Finance and Economics, 2: 319–31. [Crossref], [Web of Science ®], [Google Scholar]; Murphy, JJ 1999 …

Technical analysis and National Stock Exchange of India: testing the RSI rule using CNX Nifty indexTechnical analysis and National Stock Exchange of India: testing the RSI rule using CNX Nifty index
www.inderscienceonline.com [PDF]
… Note: The numbers marked with ∗∗ are significant at the 5% level for a two-tailed test. Table 2. The returns of the RSI rule … International Journal of Finance and Economics, 2: 319–31. [Crossref], [Web of Science ®], [Google Scholar]; Murphy, JJ 1999 …

The Viability of Six Popular Technical Analysis Trading Rules in Determining Effective Buy and Sell Signals:: MACD, AROON, RSI, SO, OBV, and ADLThe Viability of Six Popular Technical Analysis Trading Rules in Determining Effective Buy and Sell Signals:: MACD, AROON, RSI, SO, OBV, and ADL
search.proquest.com [PDF]
… Note: The numbers marked with ∗∗ are significant at the 5% level for a two-tailed test. Table 2. The returns of the RSI rule … International Journal of Finance and Economics, 2: 319–31. [Crossref], [Web of Science ®], [Google Scholar]; Murphy, JJ 1999 …



Q&A About RSI – Relative Strength Index


How does RSI help in determining the rate of change of prices?

The RSI value indicates the rate of change of price. A high RSI value means that the asset has increased in price over a period, while a low value indicates that the asset's price has decreased.

When should you buy or sell stocks based on divergence?

You should buy or sell stocks based on divergence

Why do investors look for divergences in market prices?

Investors look for divergences because they can exploit these divergences to make profits. Divergence occurs when two indicators move opposite each other and one indicator predicts an increase or decrease in stock prices while another indicator predicts otherwise. This divergence can be used by investors to predict future stock movements and make better investment choices.

What do values range from to indicate?

Values range from to . An RSI of 3 indicates that the asset is oversold while an RSI greater than 7 shows that the asset is in overbought position.

How does divergence occur?

Divergence occurs when two indicators move opposite each other and one indicator predicts an increase or decrease in stock prices while another indicator predicts otherwise. For example, if an investor expects a rise in stock prices but sees decreasing volume on increasing share price, this could be considered as divergence between volume and share price movement which may cause further fall in share prices due to lack of demand for shares at current levels. On the contrary, if there are increasing volumes with rising share price then this could be considered as convergence between volume and share price movement which may cause further rise in share prices due to strong demand for shares at current levels.

What is RSI?

Relative Strength Index (RSI) is a technical analysis tool that helps investors make investment decisions.