WHAT IS RELATIVE
STRENGTH INDEX?
The Relative Strength Index (RSI) is a technical momentum
indicator which measures the strength of the current price by tracking changes
in its previous closing prices. It is developed by J. Welles Wilder, Jr., a
very famous technical analysts.
Wilder is very famous about his several works on technical
indicators like the Average True Range (ATR), Relative Strength Index (RSI),
Parabolic SAR and Average Directional Index.
HOW TO CALCULATE THE
RSI?
The Formula in calculating the RSI is the following:
RSI = (100
– (100/ (1 + RS)))
Calculate RS using the following formula.
RS = 14 Day EMA of the Closing
Gains / 14 Day EMA of the Closing Losses
Your spreadsheet should be look like the table shown in Fig. 1 below.
 |
| Fig. 1. RSI Spreadsheet |
To download the above RSI Spreadsheet, click HERE!
IDENTIFY OVERBOUGHT OR OVERSOLD CONDITION
One of the very relevant use of Relative Strength Indicator is
identifying the overbought or oversold condition of a certain stock. (See Fig. 2 below)
 |
| Fig. 2. A RSI Chart |
The RSI line is plotted from 0 to 100. The 30-line is
considered the oversold line. If the stock price settled below this line, the
stock condition is said to be OVERSOLD. A buy signal is generated once the RSI
crosses above this line.
The 70 line is considered the overbought line. If the stock
price settled above this line, the stock condition is said to be OVERBOUGHT. A
sell signal is generated once the RSI crosses below the 70-line.
IDENTIFY REVERSAL SIGNALS THROUGH DIVERGENCE
Another effectiveness of RSI as an indicator is its ability to signal possible reversals through the occurrence of divergence.
Divergence occurs when the closing price of a stock makes a new high (or low) but is not confirmed with a new high (or low) in the RSI.
Divergence occurs when the closing price of a stock makes a new high (or low) but is not confirmed with a new high (or low) in the RSI.
A bullish divergence occurs, if after a stock price closed
in a new low, the RSI sets a higher low. A bearish divergence takes place when a stock price breaks out
to a new high, while the RSI formed a lower high.