The RSI is classified as relative strength momentum oscillator, measuring the velocity and magnitude of directional price movements. Momentum is the rate of the rise or fall in price. The RSI is most typically used on a 14-day timeframe, measured on a scale from 0 to 100, with high and low levels marked at 70 and 30, respectively. Shorter or longer timeframes are used for alternately shorter or longer outlooks.
More extreme high and low levels—80 and 20, or 90 and 10—occur less frequently but indicate stronger momentum. The relative strength index was developed by J. The RSI provides signals that tell investors to buy when the security or currency is oversold and to sell when it is overbought. For each trading period an upward change U or downward change D is calculated. If the last close is the same as the previous, both U and D are zero. This is fully equivalent to the aforementioned exponential smoothing.
If the average of D values is zero, then according to the equation, the RS value will approach infinity, so that the resulting RSI, as computed below, will approach 100. The smoothed moving averages should be appropriately initialized with a simple moving average using the first n values in the price series. The RSI is presented on a graph above or below the price chart. The indicator has an upper line, typically at 70, a lower line at 30, and a dashed mid-line at 50.
Wilder posited that when price moves up very rapidly, at some point it is considered overbought. Likewise, when price falls very rapidly, at some point it is considered oversold. In either case, Wilder deemed a reaction or reversal imminent. The level of the RSI is a measure of the stock’s recent trading strength. The slope of the RSI is directly proportional to the velocity of a change in the trend. The distance traveled by the RSI is proportional to the magnitude of the move.
Wilder believed that tops and bottoms are indicated when RSI goes above 70 or drops below 30. Traditionally, RSI readings greater than the 70 level are considered to be in overbought territory, and RSI readings lower than the 30 level are considered to be in oversold territory. In between the 30 and 70 level is considered neutral, with the 50 level a sign of no trend. Wilder further believed that divergence between RSI and price action is a very strong indication that a market turning point is imminent.
Bearish divergence occurs when price makes a new high but the RSI makes a lower high, thus failing to confirm. Bullish divergence occurs when price makes a new low but RSI makes a higher low. This section does not cite any sources. Wilder thought that “failure swings” above 70 and below 30 on the RSI are strong indications of market reversals. For example, assume the RSI hits 76, pulls back to 72, then rises to 77.
If it falls below 72, Wilder would consider this a “failure swing” above 70. Finally, Wilder wrote that chart formations and areas of support and resistance could sometimes be more easily seen on the RSI chart as opposed to the price chart. The center line for the relative strength index is 50, which is often seen as both the support and resistance line for the indicator. If the relative strength index is below 50, it generally means that the stock’s losses are greater than the gains. When the relative strength index is above 50, it generally means that the gains are greater than the losses.