Relative Strength Index (RSI)
The relative strength
Index (RSI) is a momentum indicator, or oscillator
was developed by Welles Wilder to measures the relative
internal strength of a security against itself.
Relative Momentum Index (RMI) and Change momentum oscillator (CMO)
both are another variation on
the RSI. The following topics start with introduction to
relative strength Index (RSI) indicator and how to
interpret relative strength index (RSI) such as
overbought and oversold signal and setting up with
difference time span to adjust the sensitivity of the
indicator react to the changes. Finally, Change Momentum
Oscillator (CMO) and Relative Momentum Index (RMI) are
explain as an alternative to relative strength index (RSI).
relative strength Index (RSI) was developed by
Welles Wilder. It is a momentum
indicator, or oscillator, that measures the relative
internal strength of a security against itself.
This should not be confused with comparative relative
strength, which compares the performance of one security
Relative Strength Index (RSI) Formula
The formula for the
Relative Strength Indicator (RSI) is as follows:
100 100 / (1 + RS)
average of x days' up closes / average of x days' down closes
= the average of x days' up closes divided by
the average of x days'
down closes. The
formula aims to overcome two problems involved in
the construction of a momentum indicator: (1) erratic
movements and (2) the need for a constant trading
band for comparison purposes. Erratic movements are
caused by sharp alterations in the values, which are
dropped off in the calculation.
For example, in a
2O-day rate of change (ROC) indicator, a sharp
decline or advance 20 days in the past can cause
sudden shifts in the momentum line even if the
current price is little changed. The RSI attempts to
smooth out such distortions.
The RSI formula not only provides this smoothing
characteristic, but also results in an indicator
that fluctuates in a constant range between 0 and
100. The default time span recommended by Wilder is
14 days, which he justified on the basis that it
was half of the 28-day lunar cycle.
Relative Strength Index
Extreme Readings and
an RSI (Relative Strength Index) moves above its
overbought zone or below its oversold zone, it indicates
that the security in question is ripe for a turn.
Readings and Failure Swings.
Any time an RSI
(Relative Strength Index) moves above its overbought
zone or below its oversold zone, it indicates that the
security in question is ripe for a turn.
significance depends upon the time frame under
consideration. An overbought or oversold
reading merely indicates that, in terms of
probabilities, a countered action is overdone or
It presents an
opportunity to consider
liquidation or acquisition, but not an actual buy
or sell signal. This can come only when the price
series itself gives a trend-reversal signal.
instance, if a security is overbought and was confirmed by a nice trend break in the
price. Compare to the
oversold reading that was not confirmed
by a price break and did not generate any meaningful
More often than not, the
RSI (Relative Strength Index) traces out a divergence. These divergences are
often called failure swings.
The RSI (Relative Strength Index) Enables accurate Comparisons
Securities on the same chart.
The longer the time span, the
narrower the RSI (Relative Strength Index) overbought and oversold lines should be
constructed and vice versa.
The default time span for
the calculation of an RSI (Relative Strength Index) is 14 periods. The overbought
and oversold lines are typically drawn at 70 and 30,
respectively. This research would indicate that
the 70 and 30 levels recommended by Wilder should be
moved farther apart to better reflect the average
overbought and oversold values.
It is important to note
that the magnitude of the oscillations of the RSI
(Relative Strength Index) is
inverse to that of most other momentum series. For
example, the ROC indicator is subject to wider
fluctuations the longer the time span. It works in an opposite way
for the RSI (Relative Strength Index). For the RSI
(Relative Strength Index), equilibrium is the halfway
point, which in this case is the 50 level. It is
therefore traditional to place the overbought and
oversold lines equidistant from this point.
We should remember
that longer time spans in the RSI (Relative Strength
Index) calculation result
in shallower swings and vice versa. Consequently,
the 70/30 combination is inappropriate when the time
span differs appreciably in either direction from
the standard 14-day period.
The terms long
and short time spans refer to the type of
data under consideration in a relative sense. For
example, a 60-day RSI (Relative Strength Index) would represent a long span
for daily data, but for monthly numbers, a 60-day
would be very short. Some
consideration should therefore be given to this factor
when the choice of a specific RSI (Relative Strength
Index) time span is being
RSI (Relative Strength Index) based on shorter-term time spans experience greater
volatility, they are more suitable for pointing out
overbought and oversold conditions. On the other hand,
longer-term spans are more stable in their trajectories
and therefore lend themselves better to the purpose of
constructing trend-lines and price patterns.
Relative Strength Index Time Span
The RSI (Relative
Strength Index) can be plotted
for any time span, the default for most
charting packages is 14-day time span selection.
divergence occurs when the moving average (MA) is
exactly half the time span of the dominant cycle. In
other words, if you make the assumption that the
primary trend of the stock market revolves around the
4-year business cycle, an MA of 24 months will give you
the greatest divergence between the high and low points
of the cycle.
In the case of the 28-day cycle, 14 days
is the correct choice, but it is important to understand
that there are many other cycles
apart from the lunar cycle. Working on this assumption,
for example, would mean that a 14-hour RSI (Relative
Strength Index) would be
inappropriate if the dominant cycle was something other
than 28 hours. The same would be true for weekly and
In practice, a 14-day
time span works quite well, but only for shorter
periods. I also use 9-, 25-, 30-, and 45-day spans. For
weekly data, the calendar quarters operate effectively,
so 13-,26-,39-, and 52-week spans are adopted. As for
monthly charts, the same recommended spans for the ROC
are also suitable for the RSI (Relative Strength Index), that is, 9, 12, 18, and
For longer-term charts,
covering perhaps 2 years of weekly data, a time span of
about 8 weeks offers enough information to identify intermediate term turning points. A 26-week RSI
(Relative Strength Index) results
in a momentum series that oscillates in a narrower
range, but nevertheless usually lends itself to
trend-lines construction. Very long term charts, going
back 10 to 20 years, seem to respond well to a 12-month
time span. Crossovers of the 30 percent oversold and 70
percent overbought barriers provide a very good
indication of major long-term buying and selling points.
When the RSI (Relative Strength Index) pushes through these extremes and then
crosses back toward the 50 level, it often warns of a
reversal in the primary trend.
To isolate major buy
candidates, it is important to remember that the best
opportunities lie where long-term momentum, such as a
12-month RSI (Relative Strength Index), is oversold. If you can also identify an
intermediate and a short-term oversold condition,
all three trends, primary, intermediate-term, and
short-term, are then in a classic conjunction to give a
high-probability buy signal.
Smoothing RSI and Trend-line Violation
trend-lines Violations and Pattern Completions
The RSI can also be used in conjunction with trend-lines
violations. Generally speaking, the longer the time span
for any particular period (daily, weekly, or monthly),
the better the opportunity for trend-lines construction.
Important buy and sell signals are generated when
trend-lines for both price and the RSI are
violated within a relatively short period. An example of the RSI's capability to form
price patterns is three
situations in which it traced out a
head-and-shoulders (H&S) formation. Each one was
confirmed by a trend break in the price. Note how the
inverse pattern, formed involved
several false oversold crossover buy signals. However,
it was not until the pattern was completed that the
price confirmed any of this by rallying above its
3-month down trend-lines.
Smoothing the RSI
is a perfectly legitimate technique to smooth the RSI.
One of my favorite approaches is to smooth a 9-day RSI
with an 8-day MA. Because the fluctuations are not as
great as the raw data, the overbought and oversold lines
are drawn at 70 and 30, not at my usual default of 80/20
for a 9-day span.
This smoothing technique is very useful
from the point of view of flagging reversals when the
indicator moves beyond its normal overbought and
oversold extremes. This form of interpretation works
pretty well except in periods experiencing strong linear
up- or downtrends.