Relative Strength Index - How Does It Work

J.Weller Wilder in 1978 developed the relative strength index as a technical tool which analyzes economic markets, and it is among the popular indicators available to traders. The relative strength index works as a momentum oscillator which identifies overbought and oversold conditions in the market. The RSI momentum oscillator deals with the speed and rate of change in price movements within the market. Relative strength index is one of the most popular indicators among traders. It is comfortable for use both individually and in combination with other traders.

How to use the relative strength index?

  The indicator puts the result and data on a scale from 0%-100%. Thus if all candlesticks on a given period are green, then the indicator value is 100%, if red it records 0%. A period is a candlestick quantity which measures the data collection. It is set in the indicator settings and is equal to 14 by default. Overbought and oversold values are also placed at the indicator and equal 70% and 30% by default respectively.

How Does It Work?

If the overbought value gets closer to 100% or the oversold value gets closer to 0%, then the signals become more precise although the quantity decreases. That moment when the indicator intercepts on a higher level means an oversold case, and when prices are increasing too high and fast soon, they are expected to decline. If the indicator catches on a lower border, it means an overbought case where prices are getting too little too fast, and they are supposed to increase. When the relative strength index indicator trend does not correspond with the pattern on the charts, many traders rely on indicator values, and this case is called divergence.

Types of divergence

There are two main types, i.e., a bullish divergence which occurs when the relative strength indicator creates reading followed by a higher low that matches correspondingly lower lows in the price. A bearish divergence which occurs when the relative strength indicator creates an overbought reading followed by a lower high that matches correspondingly higher highs on the price.

Calculating The Relative Strength Index.

When calculating the relative strength indicator, one needs a robust and in-depth explanation. Therefore the best way for one to understand the concepts easy, one has to read Wilder’s 1978 book New Concepts In Technical Trading System. This book will give a detailed explanation of the ideas. However, the formula can be simplified as follows: RSI=100-[100/(1+(AVERAGE OF UpWard Price of Change/ Average Downward Price Change)]

How does Relative Strength Index work in markets?

The relative strength index measures the magnitude of recent overbought and oversold conditions. The RSI technical tool can work in any market. Although it can work in any market, it is mainly prevalent in huge markets such as stock and forex markets.

What are other beneficial tools to use with the Relative Strength Index?

Relative Strength Index functions as a tool that confirms trend formations in markets. • When a trend is forming, take a quick look at the relative strength indicator. Take a closer look at whether it is above or below 50. • If you are looking at a potential uptrend, make sure the relative strength indicator is over 50. When you examine a possible downtrend, then make sure the Relative Strength Index is below 50.

How do you understand overbought and oversold readings on the relative strength index?

In huge markets, the idea that an oversold reading on the relative strength index is an uptrend is slightly higher than 30%. In an overbought reading on the relative strength indicator during a downtrend is much lower than the 70% level. During a downtrend, the relative strength indicator would peak near the 50% level rather than 70%. Investors use this to mere reliably signal bearish conditions. Many investors will apply horizontal trendline that is between 30% or 70% levels when a strong trend is in place. Modifying overbought levels when the price of a stock or asset is in the long-term horizontal channel is usually unnecessary.