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Username Post: What is the RSI (Relative Strength Index) and How Is It Used?
Posts 249
05-11-09 12:44 PM - Post#3018    

The Relative Strength Index (RSI) compares the strength of a stock's recent gains to the weakness of its recent losses and turns that information into a number that ranges from 0 to 100. The Relative Strength Index compares upward movements in closing price to downward movements over a selected period. This could be used for short cycles and for 21 or 25 days for the intermediate cycle. Relative Strength Index is smoother than the Momentum or Rate of Change oscillators and is not as susceptible to distortion from unusually high or low prices at the start of the window. It is also formulated to fluctuate between 0 and 100, enabling fixed Overbought and Oversold levels. The term "Relative Strength Index" appears to be slightly misleading as the RSI only figures out the internal strength of a single security, but does not compare the strength of two securities on any such parameters discussed.

The Relative Strength Index (RSI) is a financial technical analysis oscillator showing price strength by comparing upward and downward close-to-close movements. The RSI is popular because it is relatively easy to interpret. It is calculated using the following formula:
RSI= 100-100/1+RS.
RS= Average of x day’s up closes/ Average of x day’s down closes.
An asset or stock is deemed to be overbought once the RSI approaches the 70 level, meaning that it may be getting overvalued and is a good candidate for testing fresh resistance levels. Conversely, if the RSI approaches 30, it is an indication that the asset/ stock may be getting oversold and therefore likely to become undervalued.

The theory of RSI was developed by J. Welles Wilder and published in “ Commodities”magazine (now called “Futures” magazine) in June 1978, and in his “New Concepts in Technical Trading Systems” the same year.
J. Welles Wilder is best known for his technical indicators – now considered to be core indicators in technical analysis software. These include Average True Range, the Relative Strength Index, Directional Movement and the Parabolic Stop and Reverse. He has written many articles on trading and conducted technical trading seminars in Asia, Australia, Canada, USA, and Europe.

In the charts given above, the lower chart suggests the level of RSI in the stock, and in this case, the stock has become oversold and ripe for purchase around the month of March. Later on, the stock has also reached a high level exceeding 70 for RSI in November, and gives the first signal of exit.

One of the main advantages of following relative strength index theory in financial markets on charts is that is gives an early indication of overbought levels and oversold levels, when the RSI nears 70 and 30 respectively. Those allow the traders to make an early exit and entry into the stock/ inidces or commodities in the financial market.

1. Relative Strength, Comparative at
2. Cutler's RSI page at Aspen Graphics Technical Analysis Software
3. New Concepts in Technical Trading Systems by J. Welles Wilder,

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