Relative Strength Index is an indicator developed by Welles Wilder to assess the strength or the weakness of the current price movements and to measure the velocity of price changes by comparing price increases with its losses over a certain period.
How to Use RSI Indicator
The Relative Strength Index allows to identify possible overbought and oversold areas, but should be considered within trend analysis:
- Generally if the RSI indicator climbs above 70, the asset may be overbought;
- If the RSI indicator drops below 30, the asset may be oversold.
Leaving extreme areas the indicator may suggest possible corrections or even trend changes:
- Crossing the overbought boundary from above, the RSI signals a possible sell opportunity;
- Crossing the oversold boundary from below, the RSI signals a possible buy opportunity.
Convergence/divergence patterns may indicate possible trend weakness:
- If the price climbs to a new high, but the indicator does not, that may be a sign of the uptrend weakness;
- If the price falls to a new low, but the indicator does not, that may be a sign of the downtrend weakness.
RSI Trading Strategy
RSI trading strategy aims to generate buy and sell signals by the horizontal lines that appear on the chart at the 70 and 30 values. As we have already mentioned above, a move under 30 indicates an oversold condition and a move above 70 signals an overbought condition.
Thus, if a trader is looking for a buying opportunity, he watches the indicator dip under 30. A crossing back above 30 is considered by many traders as a confirmation that the trend has turned up. Conversely, if a trader seeks for a selling opportunity, he watches the indicator cross above the 70 line.
Relative Strength Index Formula (RSI Calculation)
To calculate the RSI, it is necessary to determine the value of the relative strength (RS) which, according to the advice of the author of the index is calculated for a 14-day period.
RSI = 100 – 100/(1 + RS) RS (14) = Σ(Upward movements)/Σ(|Downward movements|)