Developed in 1978 by J. Welles Wilder Jr., the Relative Strength Index (RSI) is a technical analysis tool that’s used to measure the speed and change in price movements. Popular with traders, knowing how to use the Relative Strength Index can be helpful for anyone who wants to get involved with technical trading. Read on for a little more insight into the meaning of the Relative Strength Index.
Relative Strength Index meaning
So, what is the Relative Strength Index? Put simply, the Relative Strength Index (RSI) is a momentum oscillator for technical trading analysis. It’s used to measure the magnitude and speed of price movements, oscillating between zero and 100. In other words, it measures the ratio of down-moves to up-moves and expresses it in the form of a number from 0-100. This can help you understand the primary trend of stocks or assets.
How to calculate the Relative Strength Index
Learning how to calculate the Relative Strength Index value of a particular stock or asset isn’t a necessary prerequisite to using the tool. Still, it can give you a little more insight into how the indicator generates the values you see on your screen. The Relative Strength Index (RSI) is computed with a two-part calculation. The first formula is as follows:
RSI Step One = 100 – (100 / (1 + (Average Gain / Average Loss)))
Here, the average loss or gain is simply the average percentage loss or gain in a look-back period. Typically, you’ll use 14 periods to figure out the initial RSI value. Then, once these 14 periods of data are available, you can begin the second step in the calculation. The second formula is as follows:
RSI Step Two = 100 – (100 / (1 + (Previous Average Gain*13 + Current Gain / Average Average loss*13 + Current Loss)))
It’s worth noting that, in some cases, traders will decide to use different Relative Strength Indicator settings. While 14 periods are suitable for swing traders, some traders may wish to lower their time frame, thereby increasing the sensitivity of the oscillator. Day traders will often use 9-11 periods, while long-term position traders may use a higher period, i.e., 20-30.
How to use the Relative Strength Index
Knowing how to use the Relative Strength Index is essential, but while all the graphs, formulas, and terminology might seem complicated, it’s actually a relatively simple tool. Put simply, the Relative Strength Index is like a Stochastic indicator, so you can use the RSI to pick potential bottoms and tops, depending on whether the market is oversold or overbought. Here’s a little more detail about some of the insights you can glean from the Relative Strength Index (RSI):
Overbought signals – Generally speaking, Relative Strength Index values of 70 or more indicate that a particular security is overvalued/overbought, and may be primed for a corrective pullback. As such, you consider this a “sell signal.”
Oversold signals – By contrast, RSI values of 30 or less may indicate that a security is undervalued or oversold and may suggest that there’s been an increase in the possibility of price strengthening. This means that you may have found an excellent opportunity to buy.
What is a divergence signal?
In addition to overbought and oversold signals, you should also pay attention to Relative Strength Index (RSI) divergence signals. Essentially, when the highs/lows of the market price move in different directions to the highs/lows of the RSI indicator, you’re dealing with a divergence signal. With a bullish divergence, the security makes a lower low, and the RSI makes a higher low. With a bearish divergence, on the other hand, the security has a higher high, and the RSI has a lower high, indicating weakening momentum.
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