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decoding rsi what is relative strength index and how is it used
when it comes to gauging the momentum of a security there are many indicators available
such as commodity channel index or cci stochastic oscillator rate of change or roc etc however one
indicator the relative strength index or rsi introduced in june 1978 by j wells wilder is
probably the most popular amongst all of them and just like other oscillators rsi oscillates between
upper and lower bounds 0 and 100 respectively to indicate overbought oversold levels the
indicator is based on the assumption that after a significant advance in a relatively short span of
time the security tends to become overbought and hence is poised for a correction and similarly
when a security has fallen sharply in a short span it tends to become oversold indicating the
likelihood of a bounce back how is rsi calculated the indicators simply measures the strength of a
security against its history of price change by comparing up days when price has increased
compared to the previous day to down days when price has decreased compared to the previous day
so to calculate rs iron gains you take the sum of the gains over the selected time frame and
divide it by that specific time frame the same formula is used to calculate the rsi for losses
rs is calculated by taking the amount of gains and dividing it by the losses so all in all rsi is
calculated by finding the rs number calculated by gains divided by losses adding the number by one
and then finding how many times that number can be divided into one hundred finally you take that
full number away from one hundred to see more of this information you can head to our website
calkinemedia.com and look at the formula there how to make decisions with rsi overbought oversold
zones as the rsi measures the intensity with which a security has risen or fallen it is up
to the user to decide the rsi levels where he would consider the security to be overbought
or oversold and traditionally these levels are below 30 for oversold and above 70 for overbought
however they can be modified to 20 and 80 as well or any other level as per the analyst
interpreting signals generated by the rsi is quite simple whenever rsi rises above 30
it is interpreted as a buy signal and similarly when the rsi falls but below 70
it is taken as a signal of weakness and hence a cell signal this is the most common use of the rsi
however with rsi being a very versatile indicator there are quite a few ways to interpret this
indicator trend identification although the rsi is not a trend following indicators some analysts
keep a close eye on level 50 being a midpoint of the entire range it also helps to figure
out the current bias of direction of the security if rsi is below 30 the trend could be interpreted
as negative and above 50 a positive trend helps to spot divergence indicators which are based on
price or in other words are derivatives of price should move in tandem with the price which is
the case most often but sometimes the indicator does not follow the price quite precisely and
tends to diverge and this disagreement between the price and its indicator is called a divergence
and is often an indication of a reversal a bearish divergence occurs when the price makes
two consecutive higher highs but the indicator's second high falls to breach the preceding high
similarly a bullish divergence occurs when the price makes two consecutive lower lows but the
indicator fails to replicate that and the rsi is very commonly used to spot these divergences to
catch short-term tops and bottoms or to do mean reversion trading failure swings another popular
way the rsi generates an actionable signal is through a failure swing a failure swing occurs
when the rsi and price move diverge from each other in an upswing the price hits a new high
and the rsi turns from the overbought levels as the price surges further the rsi fails to cross
the previous peak and turns down once again and however this time the rsi breaks the low
made during the previous swing which is a sign of weakness and the exact opposite scenario
occurs during a bearish move this signal is also interpreted as a reversal signal
patterns in rsi one increasingly popular and highly effective method to interpret rsi
is to draw some patterns trend lines and support and resistance levels etc as being traditionally
drawn in the price chart for example a trendline breakout in rsi is interpreted
in the same way as a trendline breakout on a price chart with same implications
other examples could be rsi bouncing off a strong support level that levels could be given
a high relevance and may be interpreted as a sell signal if that support level gets breached
ideal market conditions to use rsi just as with other oscillators the rsi also requires a
favorable market condition to be more effective and might not work in every market environment and
being an oscillator the rsi works best in a range bound market or a consolidation phase where the
security is bouncing off between an established support and resistance level and this is an ideal
condition to use the rsi to attempt to catch these reversal points in the range however if the market
or security is trending either up or down the rsi could easily fall prey to false signals and the
simple reason being when the market is strongly trending the rsi would generate the overbought
or oversold zones and give a sell signal on correction in a bull market and a buy signal
on rallies in a bear market however most of the time the corrections in a bull run
are just an opportunity to buy and not to take a short call at the top similarly trying to catch a
bottom in a bear market considering it as oversold generally doesn't pay well therefore the use of
rsi should be avoided during a strong trend thanks for joining us on this report if you like this
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