What is Relative Strength Index (RSI)?

Short Answer

The Relative Strength Index (RSI) is a technical analysis instrument that is used to assess if an asset or commodity is wildly overvalued or oversold by comparing the extent of rapid price momentum.

Detailed Answer

RELATIVE STRENGTH INDEX- RSI:

  • It is one of the most common and popular oscillators of momentum.
  • It was developed in the year 1978 by J. Welles Wilder Jr. in his book named as ‘New concepts in Trading system’.
  • The velocity and magnitude of a security's price changes are measured by a momentum oscillator and hence, they are its main components.
  • They are considered oscillators because they can go to both extremes and show variations.
  • These oscillators can be read between 0 to 100.
  • This is also generally measured with the period of 14 days.
  • The RSI compares the extent of a security's cumulative gains and losses over a fixed time span to draw conclusions about its strength and weakness.
  • The RSI primarily shows whether a stock is overbought or oversold in the market.
  • When the RSI is above 70%, an asset is considered overbought, and when it is below 30%, it is considered oversold.

FORMULA OF RSI:

The following formula is used to measure the RSI:

RSI = 100 – {(100 / 1 + RS)}

RS = Average of Upward Price Change/ Average of Downward Price Change.

Here is the formula of above terms to understand the formula even better:

Average of Upward Price Change= {(Past Average Gain) x 13 + Current Gain} ÷ 14

Average of Downward Price Change= {(Past Average Loss) x 13 + Current Loss} ÷ 14

DENOMINATIONS AS PER THE RSI VALUE:

  • RSI value of 50 denotes neutral state.
  • RSI value above 50 denotes that the market is bullish, and the assets or securities are overbought.
  • RSI value below 50 denotes that the market is bearish, and the assets or securities are oversold.

BENEFITS OF RELATIVE STRENGTH INDEX:

  • RSI may be used to produce trade signals, measure sentiment, or supplement other research methods by traders.
  • When used in its traditional application, the RSI is a short- to optimal predictor.
  • The charts of RSI can also help you to understand how the securities or asset will perform.
  • Situations that are oversold, or underpriced, indicate that a price rise could be on the way.

LIMITATIONS OF RELATIVE STRENGTH INDEX:

  • True reversing alerts are uncommon and distinguishing them from false positives can be complicated.
  • While the commodity in question moves in the opposite direction, the RSI indicator will remain in the overbought or oversold level for a long time.

ROLES OF RELATIVE STRENGTH INDEX:

  1. Failure Swing- when the value of RSI falls below 30 then the curve is drawn to understand the market.
  1. Application of the trend lines: The RSI provides a more developed signal that price will cross the trend line in the next day or two, in a somewhat precise manner.
  1. Pattern breakout: The RSI measures a stock's underlying relative strength over a predetermined amount of time. Such a breakout in the RSI will take place at least 2-3 days ahead of time, and the price will follow suit.
  1. Advanced breakout and breakdowns: The RSI provide an early warning, indicating that price will follow the predictor in the following exercises.
  1. Role of 50: In the case of the RSI indicator, the mid 50 line serves as a crucial line for determining price path.
Tagged With: relative strength indexRSIBenefits of RSIoscillatorsmomentum
Categories: Option Trading
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Discussion (1)

    RSI is widely used in swing trading and in intraday trading. Mostly, beginners can use this indicator in the prediction of a good opportunity to buy or short sell a stock. Majorly, the average length at which is kept at 14. But varies exponentially based on the trade and preference.

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