Trading Course for Beginners: Course 3


Lesson 6: The Relative Strength Index (RSI): An Introduction

The Relative Strength Index (RSI): An Introduction

Reading Time: 5 Minutes

Deciphering momentum—the speed of price change—is crucial for a number of trading methodologies.

As an example, if a handful of traders buy into a market and price advances, traders see this movement and trade, and before you know it, we have a surge of bullish activity.

The question most traders and investors often ask, is how long will the market remain in this state.

Are buyers going to run out of fuel or overheat?

Another way to think about this is markets are often overreacting to good and bad news.

While traders CAN view momentum change on charts, the Relative Strength Index, or more commonly referred to as: RSI, does a superb job of delivering easy-to-read momentum strength through various techniques

Developed by J. Welles Wilder, the RSI is a momentum oscillator that measures the VELOCITY of DIRECTIONAL price movement, displayed by way of a value that OSCILLATES between 0 and 100.

The basic framework of the indicator, as you can see, consists of an x axis, which represents time scale, and a y axis, signifying the magnitude or distance the indicator has moved.

Indicator levels to be mindful of are 70.00, the overbought or overvalued level, 30.00, the oversold or undervalued trigger, and 50.00, the centreline of the indicator.

For those interested in the mathematics, the calculation provides a number between 0 and 100, and it is this level traders place emphasis on.

The rather grim looking formula to calculate the RSI is essentially 100 minus 100 divided by 1 + the Relative Strength.

RSI = 100 – 100 / (1 + RS)

The relative strength—or RS—is the average of all up moves over the last 14 periods and the average of all down moves also over the previous 14 periods.

To CALCULATE the average, we simply sum the up and down moves and divide by 14—the default calculation period.

Once complete, the next step is to divide the average of the up moves by the down moves to produce the RS or relative strength.

We add this value to 1, and divide by 100.

This value is then taken from 100 to provide the RSI level.

As a quick example, assume the average gain is 0.24 and the average loss is 0.10.

Dividing the two values gives an RS of 2.4.

We then add 1 to this value to give 3.4.

Subsequent to that, we divide 100 by 3.4 to give approximately 29.41, and then minus this value from 100 to give an RSI level of 70.59 rounded.

Nevertheless, it’s recommend to use excel to compute this calculation as It runs more precise figures.

With that serving as a basic introduction, if you plan on including the RSI in your trading methods, join me in part 2 as we look to unwrap the various techniques used by professional traders.

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