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Relative Strength Index - RSI
This is part of a larger Technical Analysis site provided by Equity Analytics, Ltd.
RSI is a momentum indicator which measures an equity's price relative to itself. It is relative to its past performance. It is also front weighted. Therefore, it gives a better velocity reading than other indicators. RSI is less affected by sharp rises or drops in an equity's price performance. Thus, it filters out some of the 'noise' in a security's trading activity.
An example of RSI can be seen on Chart #103
RSI's absolute levels are 0 and 100. Traditionally, buy signals are triggered at 30, and sell signals are triggered at 70. However, many analysts are now using 20 for buy signals and 80 for sell signals. I have found some interesting variations of these buy and sell levels.
My analysis indicates that the buy and sell level will vary somewhat depending on the amount of days used in the calculation. A shorter span of days will result in a more volatile indicator which reaches further extremes. A longer amount of days used in the calculation results in a less volatile reading which reaches extremes far less often.
I have also found that despite the fact that RSI is designed to be able to measure multiple equities against each other, it doesn't quite work out that way. Some securities may pull back some when their RSI indicator reaches about 68, others at 70, etc. Different securities seem to have slightly different levels at which the price changes direction. These levels are close to each other. But they seem to be particular to each equity. Basically, the vast majority do seem to change direction at 30 and 70. My point is that this is not a hard and fast rule. There are subtle differences.
RSI treats price as a rubberband. The rubberband can be stretched just so far. After a certain point, unless it breaks, the rubberband is forced to contract. Keep in mind that trades are not placed on RSI alone. RSI is a momentum indicator which usually turns ahead of price. The important thing to remember is that price is the ultimate determinant.
RSI is also an indicator which lends itself to trendlines, support and resistance lines, and divergence. Trendlines, and support and resistance lines can be drawn in the same manner as on a price chart. Further, I have observed that they carry as much reliability on an RSI chart as they do on a price chart.
One of the more important aspects of RSI is to look for divergence between price action and RSI. Upwardly sloping price and downward sloping RSI, should be taken as a warning. Usually, one of them is wrong. More often than not, this indicates that price is about to break down. The reverse is true for downward sloping price and upward sloping RSI. It usually indicates that price is about to break out of a decline.
Formula For RSI RSI equals the average of the closes of the up days divided by the average of the closes of the down days. The time frame specified determines the volatility of the indicator. For instance, a nine day time period under study will be more volatile than a 21 day time span.
For a 22 day RSI calculation, the following are the steps involved.
Add the closing values for the up days and divide this total by 22.
Add the closing values for the down days and divide this total by 22.
Divide the up day average by the down day average. This results in the RS factor in the formula.
Add 1 to the RS.
Divide 100 by the number arrived at in step 4 above.
Subtract the number arrived at in step 5 above from 100.
Repeat steps 1-6 for day number 23. Drop day number 1 from the calculation. As enough days are accumulated, the results can be plotted in graphical format.
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