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Relative Strength Index
Description
The Relative Strength Index (RSI) is a popular oscillator used by
commodity traders. It was first introduced by J. Welles Wilder in an
article in Commodities (now known as Futures) magazine in June,
1978. Step-by-step instructions on calculating and interpreting the
RSI are also provided in Mr. Wilder's book, New Concepts in
Technical Trading Systems.
The name "Relative Strength Index" is slightly misleading as the RSI
does not compare the relative strength of two securities, but
rather the internal strength of a single security. A more
appropriate name might be "Internal Strength Index."
The RSI is a fairly simple formula, but is difficult to explain
without pages of examples. The basic formula is:
Where:
U = An average of upward price change.
D = An average of downward price change.
MetaStock Pro prompts you to enter the number of time periods in
the averages.
Interpretation
When Wilder introduced the RSI, he recommended using a
14-day RSI. Since then, the 9-day and 25-day RSIs have also gained
popularity. Because you can vary the number of time periods in the
RSI calculation, we suggest that you experiment to find the period
that works best for you. (The fewer days used to calculate the RSI,
the more volatile the indicator).
The RSI is a price-following oscillator that ranges between 0 and
100. A popular method of analyzing the RSI is to look for a
divergence in which the market index is making a new high, but the
RSI is failing to surpass its previous high. This divergence would
be an indication of an impending reversal. When the RSI then turns
down and falls below its most recent trough, it is said to have
completed a failure swing. The failure swing would be considered a
confirmation of an impending reversal.
In Mr. Wilder's book, he discusses five uses of the RSI in analyzing
commodity charts (these apply to indices as well):
- Tops and Bottoms: The RSI usually tops above 70 and
bottoms below 30 (MetaStock Pro automatically draws horizontal
lines at these levels). The RSI usually forms these tops and
bottoms before the underlying price chart.
- Chart Formations: The RSI often forms chart patterns
(such as head and shoulders or rising wedges) that may or may
not be visible on the price chart.
- Failure Swings: (also known as support or resistance
penetrations or breakouts): This is where the RSI surpasses a
previous high (peak) or falls below a recent low (trough).
- Support and Resistance: The RSI shows, sometimes more
clearly than the price chart, levels of support and resistance.
- Divergence: As discussed above, this occurs when the
price makes a new high (or low) that is not confirmed by a new
RSI high (or low).
For additional information on the RSI, refer to Mr. Wilder's
book.
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