The Relative Strength Index is a leading indictor and an Oscillator that measures the strength of a market by its closing prices.
It measures the current strength or weakness of a market based on a comparison of current to historical closing prices.
The formula to calculate RSI is:
- RSI= 100 – 100/(1+RS)
- Where RS=Average of x days’ up closes/Average of x days’ down closes.
- x is typically 7 days.
RSI is a value between 0-100 and is drawn by a line connecting the recent values.
Trading using the Relative Strength Index (RSI)
Overbought and Oversold conditions on the RSI indicator
RSI is most useful for judging Overbought and Oversold levels in a market. When the value is greater than 70 then the market is Overbought and we should anticipate a pullback. When the value is less than 30 then it is Oversold and we should anticipate a pullback.
It is worth bearing in mind that markets can remain Overbought (>70) and Oversold (<30) for a long time so it is prudent wait for the indicator to cross back over the Overbought or Oversold line before making a decision on a pullback.
In an uptrend when the RSI indicator drops below the 30 line and then moves back above the 30 line this indicates that the pullback is over and the trend is ready to resume. Cover your shorts here and go long.
In an downtrend when the RSI indicator move above the 70 line and then moves back below the 70 line this indicates that the pullback is over and the downtrend is ready to resume. Sell your long positions here and go short.
Bearish and Bullish Divergence
In an uptrend and when price makes a new high but the RSI makes a lower high this is a bearish divergence, time to sell longs go short.
In an downtrend and when price makes a new low but the RSI makes a higher low this is a bullish divergence, time to cover shorts and go long.