Pathshala: RSI

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<span style="font-family: "arial" , "helvetica" , sans-serif;">Relative strength Index or just RSI, is a very popular indicator 
developed by J.Welles Wilder. RSI is a leading momentum indicator which 
helps in identifying a trend reversal.</span><br />
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<span style="font-family: "arial" , "helvetica" , sans-serif;"><span style="font-family: "arial" , "helvetica" , sans-serif;">T</span>he Relative Strength 
Index (RSI) is an oscillator that measures current price strength in relation to 
previous prices. The RSI is a versatile tool, it can be used to:</span></div>
<ul style="text-align: justify;">
<li><span style="font-family: "arial" , "helvetica" , sans-serif;"><b>Generate buy and sell signals </b></span></li>
<li><span style="font-family: "arial" , "helvetica" , sans-serif;"><b>Show overbought and oversold conditions </b></span></li>
<li><span style="font-family: "arial" , "helvetica" , sans-serif;"><b>Confirm price movement </b></span></li>
<li><span style="font-family: "arial" , "helvetica" , sans-serif;"><b>Warn of potential price reversals through divergences </b></span></li>
</ul>
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<span style="font-family: "arial" , "helvetica" , sans-serif;">Formula </span></h3>
<span style="font-family: "arial" , "helvetica" , sans-serif;">The formula to calculate the RSI is as follows:</span><br />
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Let us understand this indicator with the help of the following example:<br />
Assume the stock is trading at 99 on day 0, with this in perspective; consider the following data points:<br />
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In the above table, points gained/lost denote the number of points 
gained/lost with respect to the previous day close. For example if 
today’s close is 104 and yesterday’s close was 100, points gained would 
be 4 and points lost would be 0. Similarly, if today’s close was 104 and
 previous day’s close was 107, the points gained would be 0 and points 
lost would be 3. Please note that, the loses are computed as positive 
values.<br />
We have used 14 data points for the calculation, which is the default
 period setting in the charting software. This is also called the 
‘look-back period’. If you are analyzing hourly charts the default 
period is 14 hours, and if you are analyzing daily charts, the default 
period is 14 days.<br />
The first step is to calculate ‘RS’ also called the RSI factor. RS as
 you can see in the formula, is the ratio of average points gained by 
the average points lost.<br />
Average Points Gained = 29/14<br />
= 2.07<br />
Average Points Lost = 10/14<br />
= 0.714<br />
RS = 2.07/0.714<br />
= 2.8991<br />
Plugging in the value of RS in RSI formula,<br />
= 100 – [100/ (1+2.8991)]<br />
= 100 – [100/3.8991]<br />
= 100 – 25.6469<br />
<b>RSI = 74.3531</b><br />
As you can see RSI calculation is fairly simple. The objective of 
using RSI is to help the trader identify over sold and overbought price 
areas. Overbought implies that the positive momentum in the stock is so 
high that it may not be sustainable for long and hence there could be a 
correction. Likewise, an oversold position indicates that the negative 
momentum is high leading to a possible reversal.<br />
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<span style="font-family: "arial" , "helvetica" , sans-serif;">The chart below shows how the RSI can generate easy to follow 
      buy and sell signals:</span></div>
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<h2 class="buy" style="text-align: justify;">
<span style="font-family: "arial" , "helvetica" , sans-serif;"><span style="color: lime;">RSI Buy Signal</span></span></h2>
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<span style="font-family: "arial" , "helvetica" , sans-serif;">Buy when the RSI crosses above the oversold line (30).</span></div>
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<h2 class="sell" style="text-align: justify;">
<span style="font-family: "arial" , "helvetica" , sans-serif;"><span style="color: red;">RSI Sell Signal</span></span></h2>
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<span style="font-family: "arial" , "helvetica" , sans-serif;">Sell when the RSI crosses below the overbought line (70).</span></div>
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<span style="font-family: "arial" , "helvetica" , sans-serif;">Varying the time period of the Relative Strength Index can increase or 
      decrease the number of buy and sell signals. In the chart below of Gold, two RSI 
      time periods are shown, 14-day (default) and 5-day. Notice how decreasing the 
      time period made the RSI more volatile, increasing the number of buy and sell 
      signals substantially.</span></div>
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<b><span style="font-family: "arial" , "helvetica" , sans-serif;">There is another way the Relative Strength Index gives buy and sell signals. Given Below-</span></b></div>
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<span style="font-family: "arial" , "helvetica" , sans-serif;">RSI Divergences</span></h3>
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<span style="font-family: "arial" , "helvetica" , sans-serif;">An alternative way that the Relative Strength Index (RSI) gives buy and sell 
signals is given below:</span></div>
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<li><span style="font-family: "arial" , "helvetica" , sans-serif;">Buy when price and the Relative Strength Index are both rising and the RSI 
        crosses above the 50 Line. </span></li>
<li><span style="font-family: "arial" , "helvetica" , sans-serif;">Sell when the price and the RSI are both falling and the RSI crosses below 
        the 50 Line. </span></li>
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<span style="font-family: "arial" , "helvetica" , sans-serif;">An example of this methodology for buying and selling based on 50 Line 
      crosses is given below in the chart-</span></div>
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<span style="font-family: "arial" , "helvetica" , sans-serif;">For another interesting and under-utilized method for using the RSI indicator 
      for buy and sell signals, see: <b><span style="color: blue;">Stochastic RSI</span>,</b> 
      which combines both the popular Stochastics indicator and the Relative Strength 
      Index. </span></div>
<h3 style="text-align: justify;">
<span style="font-family: "arial" , "helvetica" , sans-serif;">Relative Strength Index Confirmations & Divergences</span></h3>
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<span style="font-family: "arial" , "helvetica" , sans-serif;">A powerful method for using the Relative Strength Index is to confirm price 
      moves and forewarn of potential price reversals through RSI Divergences.</span></div>
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<span style="font-family: "arial" , "helvetica" , sans-serif;">The chart below contract shows the RSI 
      confirming price action and warning of future price reversals:</span></div>
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<span style="font-family: "arial" , "helvetica" , sans-serif;">Low #1 to Low #2    </span></h3>
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<span style="font-family: "arial" , "helvetica" , sans-serif;">The E-mini Nasdaq 100 Futures contract's price made a substantial move from 
      Low #1 to Low #2. The RSI confirmed this move, helping a trader have confidence 
      jumping on board the price move higher. The break of trendline of the e-mini future was also confirmed by the 
      trendline break of the Relative Strength Index, confirming that the price move 
      was likely over.
    </span></div>
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<span style="font-family: "arial" , "helvetica" , sans-serif;">Low #3 to Low #4</span></h3>
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<span style="font-family: "arial" , "helvetica" , sans-serif;">A bullish divergence was registered between Low #3 and Low #4. The e-mini 
      Nasdaq 100 future made lower lows, but the RSI failed to confirm this price 
      move, only making equal lows. An astute trader would see this RSI divergence and 
      begin taking profits from their shortsells.</span></div>
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<span style="font-family: "arial" , "helvetica" , sans-serif;">High #1 to High #2</span></h3>
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<span style="font-family: "arial" , "helvetica" , sans-serif;">A bearish divergence occured when the e-mini futures contract made a higher 
      high and the RSI made a lower high. This bearish divergence warned that prices 
      could be reversing trend shortly. A trader should consider reducing their long 
      position, or even completely selling out of their long position.<b> </b>The Relative Strength Index is a popular tool for generating buy and sell 
      signals, confirming trends, and warning of impending price reversals.</span><br />
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<span style="font-family: "arial" , "helvetica" , sans-serif;">Note </span></h3>
<span style="font-family: "arial" , "helvetica" , sans-serif;">None of the parameters used while analyzing RSI should be treated 
with rigidity. For example, J.Welles Wilder opted to use a look back 
period of 14 days simply because that was the value which gave the best 
results considering the market conditions in 1978 (which is when RSI was
 introduced to the world). You may choose to use 5,10,20, or even 100 
days look back period if you wish too. In fact this is how you develop 
your edge as a trader. You need to analyze what works for you and adopt 
the same. Please note, fewer the days you use to calculate the RSI, the 
more volatile the indicator would be.</span><br />
<span style="font-family: "arial" , "helvetica" , sans-serif;">
</span><span style="font-family: "arial" , "helvetica" , sans-serif;">Also, J.Welles Wilder decided to use 0-30 level to indicate oversold 
regions and 70-100 level to indicate overbought region. Again this is 
not set in stone, you can arrive at you own combination.</span><br />
<span style="font-family: "arial" , "helvetica" , sans-serif;">
</span><span style="font-family: "arial" , "helvetica" , sans-serif;">I personally prefer to use 0-20 level and 80-100 level to identify 
oversold and overbought regions respectively. I use this along with the 
classical 14 day look back period.</span><br />
<span style="font-family: "arial" , "helvetica" , sans-serif;">
</span><span style="font-family: "arial" , "helvetica" , sans-serif;">Of course, I urge you to explore parameters that work for you. In 
fact this is how you would eventually develop as a successful trader.</span><br />
<span style="font-family: "arial" , "helvetica" , sans-serif;">
</span><span style="font-family: "arial" , "helvetica" , sans-serif;">Finally, do remember RSI is not used often as a standalone indicator 
by  traders, it is used along with other candlestick patterns and 
indicators to study the market.</span><br />
<h3>
<span style="font-family: "arial" , "helvetica" , sans-serif;">Key takeaways </span></h3>
<ol>
<li><span style="font-family: "arial" , "helvetica" , sans-serif;">Indicators are independent trading systems developed, and introduced by successful traders</span></li>
<li><span style="font-family: "arial" , "helvetica" , sans-serif;">Indicators are leading or lagging. Leading indicators signals the 
possible occurrence of an event. Lagging indicators on the other hand 
confirms an ongoing trend</span></li>
<li><span style="font-family: "arial" , "helvetica" , sans-serif;">RSI is a momentum oscillator which oscillates between 0 and 100 level</span></li>
<li><span style="font-family: "arial" , "helvetica" , sans-serif;">A value between 0 and 30 is considered oversold, hence the trader should look at buying opportunities</span></li>
<li><span style="font-family: "arial" , "helvetica" , sans-serif;">A value between 70 and 100 is considered overbought, hence the trader should look at selling opportunities</span></li>
<li><span style="font-family: "arial" , "helvetica" , sans-serif;">If the RSI value is fixed in a region for a prolonged period, it 
indicates excess momentum and hence instead of taking a reversed 
position, the trader can consider initiating a trade in the same 
direction.</span></li>
</ol>
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Relative strength Index or just RSI, is a very popular indicator developed by J.Welles Wilder. RSI is a leading momentum indicator w...