Developed by J. Welles Wilder, the Relative Strength Index (RSI) is a momentum oscillator that measures the speed and change of price movements. RSI oscillates between zero and 100. Traditionally, and according to Wilder, RSI is considered overbought when above 70 and oversold when below 30. Signals can also be generated by looking for divergences, failure swings, and centerline crossovers. RSI can also be used to identify the general trend.
RSI is an extremely popular momentum indicator that has been featured in a number of articles, interviews, and books over the years. In particular, Constance Brown's book, Technical Analysis for the Trading Professional, features the concept of bull market and bear market ranges for RSI. Andrew Cardwell, Brown's RSI mentor, introduced positive and negative reversals for RSI. In addition, Cardwell turned the notion of divergence, literally and figuratively, on its head.
Wilder features RSI in his 1978 book, New Concepts in Technical Trading Systems. This book also includes the Parabolic SAR, Average True Range and the Directional Movement Concept (ADX). Despite being developed before the computer age, Wilder's indicators have stood the test of time and remain extremely popular.
To simplify the calculation explanation, RSI has been broken down into its basic components: RS, Average Gain and Average Loss. This RSI calculation is based on 14 periods, which is the default suggested by Wilder in his book. Losses are expressed as positive values, not negative values.
Taking the prior value plus the current value is a smoothing technique similar to that used in calculating an exponential moving average. This also means that RSI values become more accurate as the calculation period extends. SharpCharts uses at least 250 data points prior to the starting date of any chart (assuming that much data exists) when calculating its RSI values. To exactly replicate our RSI numbers, a formula will need at least 250 data points.
Wilder's formula normalizes RS and turns it into an oscillator that fluctuates between zero and 100. In fact, a plot of RS looks exactly the same as a plot of RSI. The normalization step makes it easier to identify extremes because RSI is range bound. RSI is 0 when the Average Gain equals zero. Assuming a 14-period RSI, a zero RSI value means prices moved lower all 14 periods. There were no gains to measure. RSI is 100 when the Average Loss equals zero. This means prices moved higher all 14 periods. There were no losses to measure.
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Relative Strength Index (RSI) can be used both separately and together with other indicators in the Strategy Builder.