Relative Strength Index (RSI)
The Relative Strength Index (RSI) compares the average change in price of a security in declining periods to the average change in price in advancing periods. You can choose the time period you'd like to use, but many analysts recommend using a period of 14 days. Because RSI is a momentum oscillator, its values range from 0 to 100.
RSI compares a security's average gain and average loss over a given time period. When the average gain is greater than the average loss, the RSI rises, so when prices rise, RSI increases as well. When prices fall, RSI will decrease too.
RSI is used to indicate overbought and oversold levels. Some analysts recommend using 70 and 30 to signify that a stock is overbought or oversold, respectively. They further argue that if RSI rises above 30, the stock is thought to signify the beginning of an uptrend, and if it falls below 70, prices may start on a downtrend.
In addition, positive and negative divergences are also thought to indicate future price trends. For example, if the stock's price is falling, but RSI is increasing, some analysts believe this positive divergence signals that the price will soon reverse to mirror RSI. Similarly, if the security's price is rising, but RSI is falling, this negative divergence signals that prices may begin to decline as well.
Furthermore, any readings above 50 (the center line) are considered to be bullish - or at least signify that average gains are higher than average losses - and readings below 50 are said to be bearish, that there are more average losses than gains. Large surges and drops in and asset's price may create false buy or sell signals, so most traders will use RSI only in concert with other tools and indicators.
The RSI is a fairly simple formula, but is difficult to explain without pages of examples. The basic formula is:
U = An average of upward price change
D = An average of downward price change
The strategies described in this article are for information purposes only, and their use does not guarantee a profit. None of the information provided should be considered a recommendation or solicitation to invest in, or liquidate, a particular security or type of security. Investors should fully research any security before making an investment decision. Securities are subject to market fluctuation and may lose value.