Relative Strength Index Explained

Indicator | by ForexCycle.com | Tuesday, 24 February 2009 05:00 UTC

Relative Strength Index (RSI) is used to quantify the strength of the entire set of ascending movements in opposition to all descending movements within a given period of time. The following is the Relative Strength Index equation:

RSI = 100 - [100/(1+RS)]

RS is the ratio between the average gain of day n and the average loss of day n.

Period fourteen is the most frequently used RSI value, but traders may choose any time period according to their preference. RSI figures among the most widely used oscillators which can be successfully employed in range bound markets.

The scope of RSI is from zero to one hundred. Let us say that in the above equation, RS equals one. This signifies that the average gain of day n is the same as the average loss of day n, hence giving us an RSI of fifty. The ascending force of the market is thus the same as its descending force. When RSI is higher than fifty, the ascending force is more powerful. Conversely, when RSI is below fifty, the descending force outweighs the ascending force.

RSI is employed to detect whether a market is overbought or oversold. The market is viewed as being overbought when RSI is higher than seventy and, consequently, a signal to sell is emitted. When RSI is below the value of thirty, this tells us that the market is oversold and we are given a signal to buy.

We also use the Relative Strength Index to recognize divergence. When the price is close to the level of support/resistance and RSI starts diverging and not going in the same direction, this tells us that there might be a lessening of a trend's power. Divergence may point towards a reduction in the force of the trend or that a reversal is imminent.

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