Relative Strength Index (RSI)
Introduction
Developed by J. Welles Wilder and introduced in his 1978 book, New Concepts in
Technical Trading Systems, the Relative Strength Index (RSI) is an extremely
useful and popular momentum oscillator. The RSI compares the magnitude of a
stock's recent gains to the magnitude of its recent losses and turns that
information into a number that ranges from 0 to 100. It takes a single
parameter, the number of time periods to use in the calculation. In his book,
Wilder recommends using 14 periods.
The RSI's full name is actually rather unfortunate as it is easily confused
with other forms of Relative Strength analysis such as John Murphy's "Relative
Strength" charts and IBD's "Relative Strength" rankings. Most other kinds of
"Relative Strength" stuff involve using more than one stock in the calculation.
Like most true indicators, the RSI only needs one stock to be computed. In
order to avoid confusion, many people avoid using the RSI's full name and just
call it "the RSI."
Calculation
100
RSI = 100 - --------
1 + RS
RS = Average Gain / Average Loss
Average Gain = [(previous Average Gain) x 13 + current Gain] / 14
First Average Gain = Total of Gains during past 14 periods / 14
Average Loss = [(previous Average Loss) x 13 + current Loss] / 14
First Average Loss = Total of Losses during past 14 periods / 14
Note: "Losses" are reported as positive values.
To simplify our explanation of the formula, the RSI has been broken down into
its basic components which are the RS, the Average Gain, and the Average Loss.
To calculate RSI values for a given dataset, first find the magnitude of all
gains and losses for the 14 periods prior to the time where you wish to start
the calculation. (Note: 14 is the standard number of periods used when
calculating the RSI. If a different number is specified, just substitute that
number in for "14" throughout this discussion.)
It is important to understand that the RSI is a "running" calculation and the
accuracy of the calculation depends on how long ago the calculations started.
The first RSI value is an estimate - subsequent values improve on that
estimate. You should calculate at least 14 values prior to the start of any
values that you will rely on - going back 28+ periods is even better.
To start the running calculation, the First Average Gain is calculated as the
total of all gains during the past 14 periods divided by 14. Similarly, the
First Average Loss is calculated as the total magnitude of all losses during
the past 14 periods divided by 14. The next values for the "averages" are
calculated by taking the previous value, multiplying it by 13, adding in the
next Gain (or Loss), and then dividing by 14. This is Wilder's modified
"smoothing" technique in action.
The RS value is simply the Average Gain divided by the Average Loss for each
period.
Finally, the RSI is simply the RS converted into an oscillator that goes
between zero and 100 using this formula: 100 - (100 / RS + 1).
Here's an Excel Spreadsheet that shows the start of an RSI calculation in
action.
When the Average Gain is greater than the Average Loss, the RSI rises because
RS will be greater than 1. Conversely, when the Average Loss is greater than
the Average Gain, the RSI declines because RS will be less than 1. The last
part of the formula ensures that the indicator oscillates between 0 and 100.
Note: If the Average Loss ever becomes zero, RSI becomes 100 by definition.
Important Note: The more data points that are used to calculate the RSI, the
more accurate the results. The smoothing factor is a continuous calculation
that - in theory - takes into account all of the closing values in the data
set. If you start an RSI calculation in the middle of an existing data set,
your values will only approximate the true RSI value. SharpCharts uses at least
250 data points prior to the starting date of any chart (assuming that much
data exists) when calculating its RSI values. To duplicate our RSI numbers,
you'll need to use at least that much data also.
Use
Overbought/Oversold
Wilder recommended using 70 and 30 and overbought and oversold levels
respectively. Generally, if the RSI rises above 30 it is considered bullish for
the underlying stock. Conversely, if the RSI falls below 70, it is a bearish
signal. Some traders identify the long-term trend and then use extreme readings
for entry points. If the long-term trend is bullish, then oversold readings
could mark potential entry points.
Divergences
Buy and sell signals can also be generated by looking for positive and negative
divergences between the RSI and the underlying stock. For example, consider a
falling stock whose RSI rises from a low point of (for example) 15 back up to
say, 55. Because of how the RSI is constructed, the underlying stock will often
reverse its direction soon after such a divergence. As in that example,
divergences that occur after an overbought or oversold reading usually provide
more reliable signals.
Centerline Crossover
The centerline for RSI is 50. Readings above and below can give the indicator a
bullish or bearish tilt. On the whole, a reading above 50 indicates that
average gains are higher than average losses and a reading below 50 indicates
that losses are winning the battle. Some traders look for a move above 50 to
confirm bullish signals or a move below 50 to confirm bearish signals.
Example
The DELL example shows a number of extreme readings as well as a negative
divergence. In Oct-99, RSI reached oversold for a brief moment to mark the low
around 38. The next extreme reading (overbought) occurred after a large advance
that peaked in Dec-99. RSI reached overbought levels in late Dec-99 and moved
below 50 by the second week of Jan-00. The next oversold reading occurred in
Feb. for another brief moment and marked the low around 35. By the end of
Feb-00, RSI moved back above 50 and into overbought territory in March. A
negative divergence formed in March and marked the high in the upper fifties.
RSI and SharpCharts
RSI is available on our SharpCharts charting tool. In the example, RSI has been
assigned 14, 20 and 30 periods. A swing trader might prefer 14-periods, while
an investor may prefer 30-periods. Users are encouraged to test different RSI
settings and judge for themselves which ones work best and suit their
particular trading/investing style.
Click here to see a live example of RSI.
For more on oscillators, please read our ChartSchool article on how to use and
interpret oscillators.
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