RSI Indicator (Relative Strength Index) Explained

Relative Strength Index

The Relative Strength Index or in short form RSI indicator is a momentum indicator. This indicator measures the magnitude of recent price changes to analyze overbought or oversold conditions. It is also a momentum oscillator. It also measures the speed and change of price movements and this oscillator oscillates between zero and 100. This indicator is developed by J. Welles Wilder, the author of New Concepts in Technical Trading Systems. This can also be used to identify the general trend.

Relative Strength Index FAQ

What does the Relative Strength Index tell you?

The RSI indicator is a momentum oscillator. This calculates the speed of how the price is changing. As an oscillator, it oscillates between 0 and 100. Below 30 or 20 is considered as oversold whereas above 70 or 80 is considered as overbought. This also shows how a stock is bullish when RSI is above 50 and it is bearish when RSI is below 50. It also gives potential reverse signals using divergence.

How do you calculate the relative strength index?

n order to simplify the calculation process, it has been broken into this simple formula. RSI = 100 – 100 / (1 + RS) Here RS means (Average of Upward Price Change / Average of Downward Price Change). The default time frame should be in 14 (for comparing up periods to down periods is 14).

Is RSI a good indicator?

RSI is one of the basic and widely used indicators. It can give buy and sell signals using various methos. Out of them, a few are the overbought oversold strategy, centerline cross over and divergence. It is a very effective indicator and followed by traders worldwide.

What is the best period for RSI?

By default 14 is the period for the RSI indicator. So it is calculated on a 14-period basis. But we can play with the settings. I have seen 7-period is a good period to use in intraday. It can also be used for positional trading apart from intraday, as it gives the overbought oversold signals faster. There is a much faster setting used by Larry Connors. He used a 2–period version of this indicator to build a highly profitable trading system.

How to attach the RSI Indicator on trading platforms?

On Zerodha Kite

The traders can find the RSI In the Zerodha Kite platform, under the STUDIES section. It is also available in the Kite mobile App. The default Period is 14 and you can set the color of the indicator. The default period of OverBought is 80 and the OverSold is 20 you can change it also. You can show or hide the overbought oversold line. Check how we attached the indicator in Reliance Industries share price chart. We can attach the RSI indicator on to any charts likes daily, weekly, monthly or intraday.

RSI Indicator

On AmiBroker

The RSI Indicator can be used on AmiBroker, my favorite charting platform. Here a link of color-coded Relative Strength Index Amibroker formula AFL is given below.

AmiBroker Formula for Relative Strength Index

The image is given here for an example of color-coded RSI Amibroker Formula AFL. You can download the codes from the link below.

How to trade using the Relative Strength Index:

  • In Indian platforms like Zerodha Kite, the default overbought oversold levels are 80 and 20. When above 80 we consider this indicator as to the overbought condition and when below 20 then oversold condition. The traditional levels can also be adjusted if necessary. An example, if a stock is repeatedly reaching the overbought level of 80 then people want to adjust this level to 90.
  • The chart patterns of this indicator should also show the same as the underlying price chart, like double tops and bottoms and trend lines.
  • The RSI indicator in an uptrend or bull market tends to remain in the 40 to 90 range with the 40-50 zone acting as support and a downtrend. In a bear market, it tends to stay between the 10 to 60 range with the 50-60 zone acting as resistance. The RSI settings depend on these ranges and the strength of the security’s or market’s underlying trend.
  • If underlying prices make a new high or low then the indicator divergence can signal a price reversal. This indicator also makes a lower high and then its downside moves below a previous low, and it has occurred a Top Swing Failure. If the indicator makes a higher low and then its upside moves above a previous high, and it has occurred a Bottom Swing Failure.
RSI Indicator

The RSI Trading Strategies

By following this indicator, an investor can recognize these following situations:

  • Overbought situation
  • Oversold situation
  • Bearish trend
  • Bullish trend
  • Bearish Divergence
  • Bullish Divergence

As I have mentioned that RSI is a momentum oscillator that oscillates between zero and a hundred. A reading above 70 or 80 is considered overbought and below 30 or 20 oversold. The application of the indicator mainly works in the cash and futures market. Generally, investors work with the indicator based on the mid-level 50. The mid-line helps to spot the bullish and bearish trend.

RSI Indicator Trading Example

Let’s go for an example of an RSI indicator with an image so that I can clarify the subject more easily.

Relative Strength Index Trading

The above chart is attached with the RSI indicator. As you can see from zero levels to a hundred RSI oscillates. The yellow mid-line is standing at 50. Above 50 is the bullish zone while below 50 considers the bearish zone. Here we can identify the overbought level easily (above 70 levels) but in this chart, there is no oversold level, breakout happens at the level 30 twice, after the breakout the trend reverse.

Trading the RSI Indicator divergence

There is another well-known pattern you can notice by applying RSI, which is a divergence pattern. Previously I have written an article based on the bullish divergence pattern with an example of Glenmark Pharma. When the price action makes a lower low and RSI establishes a higher low, bullish divergence pattern form by the disagreement between price action and RSI. In the case of bearish divergence, the price action completes a higher high while the indicator makes a lower high.

Relative Strength Index (RSI Indicator) Divergence

Divergence trading is typically famous among traders. There are two types of divergence, bullish and bearish. Simply divergence means a disagreement between actual price action and indicators. Here if we apply RSI, then when RSI makes higher low and price makes a lower low, bullish divergence appears. The reverse pattern happens in the bearish divergence.

RSI Amibroker Formula
Bearish Divergence in AmiBroker

Besides this, there is the swing breakout which one can identify with the RSI indicator. RSI developer Welles Wilder considered the failure of swings is a very strong signal for the market trend reversal.

Suggested Reading on Relative Strength Index

I suggest the following book to understand the indicator in more detail: The Encyclopedia of the Indicator RSI: Relative Strength Index.

Conclusion

RSI indicator is a versatile momentum oscillator that has stood the test of time. It oscillates between 0 too 100. 50 is the centerline and 70 or 80 is overbought and 30 or 20 is oversold. The developer of RSI, Wilder considers overbought conditions can indicate a reversal, but overbought can also of strength. The indicator stays above the overbought level or below the oversold level for a long time during a strong trend. A Relative Strength Index value above 50 is considered bullish and its value below 50 is considered bearish. This indicator also spots divergence very accurately.

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Author: Ankita Chakraborty

Ankita has done her Diploma Engineering in Computer Science & Technology. She is pursuing her degree in Engineering and also well experienced in the equity market and real estate related content writing. She is the one who has developed the technical indicators section of our site.

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