The Relative Strength Index (RSI) is widely used by analysts who want to invest in trading, especially those who trade in Forex, the futures market and stock markets. Please note that this article can be converted into PDF and used as a practical eBook. After having carefully verified its application with Bollinger Bands, we see its functioning in other contexts as well.
The principle of the functioning of the RSI in the trading is based on the measure of the speed with which a variation of the prices occurs the so-called momentum.
The calculation made is:
In the graph it is highlighted with a line oscillating between 0 and 100. It moves upwards in a positive direction and downwards in a negative direction. In upward phases, positive closures are more and more intense in downward phases, while negative closures will be more and more intense than positive ones.
RSI = 100 - [100 / (1 + RS )
RS = average of the last n closures bullish/ average of the last n closures bearish.
The Relative Strength Index is the average of n-day bullish and bearish closures.
In the original formulation of Welles Wilder, its creator, provides a window of observation and 14 periods and is calculated using the average of the upward changes of a stock and the average of in absolute value of the downward changes.
The average of the price changes upwards plus the average of the absolute value of the price changes upwards multiplied by x 100 is used to normalise the oscillator and to ensure that it is in a range from zero to 100.
It may also be possible to meet different formulas, but in reality they will be nothing more than a different transcription of the relations between the members of the given expression. In the graphic conformation on the lower part, you will notice two horizontal lines that the oscillator crosses several times, which delimit the extreme zones of overbought and oversold.
In the Relative Strength Index the extreme zones are:
If you detect oscillator output signals from the oversold area, it is time to buy.
It is advisable to always try to adapt the levels from which the overbought and oversold areas start depending on:
The aim is to find those parameters that best describe the movements of the stock prices (in a generic sense all the financial instruments, shares, bonds, currencies, etc.) that are being analysed.
Not always the RSI oscillator behaves very well, the trader must set it correctly according to which asset you are interested in and according to market conditions. Winds moves in lateral direction, indicates the maximum and minimum oscillation, while in trend conditions, on the left side of the graph, tends to position itself in the overbought zone without providing useful information, rather, giving false signals.
Normally set to 14 periods shows good operation in trend conditions, with good indications of the turning points at the exit of the extreme zones.
The oscillator Rsi takes the value 0 when, in the interval of time considered, the average of the increments is equal to 0, value 100 when it is the average of the decrements to result equal to 0. It is therefore deduced that its value can only vary within the range 0-100 points: for this reason it is said that the Rsi is an oscillator and not an indicator, for the simple reason that the latter, on the other hand, could potentially go down or go up to infinity.
The three basic characteristics of an oscillator in detail are:
The number of days chosen may vary, although 14 are often used in accordance with the period Wilder chose for his studies. The number of periods used in the calculation of the Rsi can be modified anyway: for this reason, it is suggested to experiment with the oscillator in order to find the length that best fits its operation.
From an operational point of view, the RSI is of great value.
In the directional market phases, the fact that RSI is in a strong "overbought", in a bullish market, or in a strong "oversold", in a bearish market, is a confirmation of the trend in place. Reaching the overbought and oversold areas anticipates, in some cases, the beginning of a technical correction or rebound.
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