The Relative Strength Index (RSI) is an oscillator used for the technical analysis method. The oscillator shows price strength by comparing upwards and downwards securities and closing price fluctuations, explains IronFX.
The RSI is popular because it is relatively easy to understand. It was developed in 1978 by Welles Wilder and published in a professional booklet dealing with future commodity prices. A further development was published the same year in his book entitled New Concepts in Technical Trading Systems, says IronFX.
The term “relative strength” can refer to both the strength of the security relative to the general market and to the sector to which the security belongs. For example, a share that goes up 2% when the rest of the market goes up 1%. This value doesn’t relate to this differentiation in terms of market or sector.
The manner of calculation: for each day, upward change will be calculated as U or downward change, as D. For every day where the change is upward, that means the closing rate was higher than that of the previous day, explains IronFX.
If today’s closing rate is identical to yesterday’s, then both U and D are equal to zero. The average U is calculated using a moving exponential average using the number of days, N, as the divisor, and likewise for D. The ratio between the two averages is called the relative strength, states IronFX.
This result is converted to the Relative Strength Index, between the values of 0 and 100.
Wilder referred to securities as overbought if the RSI reached 70, which means that the broker should consider selling the security. In parallel, if the RSI drops below 30, it’s considered oversold. The idea is that if there is a high proportion of daily fluctuation in the same direction, it is an extreme occurrence, and the trend will turn on its head. Sometimes, levels of 80 and 20 are used and one can diversify according to market conditions.
Large increases or decreases in securities values will influence the RSI, but by the same token it can be a mistaken as a signal to buy or sell. Some recommend using the RSI as a complementary oscillator for other technical indicators, explains IronFX.