What Is Relative Strength Index (RSI) In Stocks?
Relative strength index (RSI) is one of the most popular and widely used technical indicators used by investors to measure the speed and magnitude of stock price movements. A relative strength index (RSI) is an oscillator-type technical indicator that measures the internal strength of a stock by comparing the magnitude of its gains and losses over a period of time. RSI is widely used by both novice and experienced traders and investors alike for trading and analyzing financial markets, such as stocks, ETFs, mutual funds, futures, currencies, and commodities.
In this article, we will look at what exactly is RSI, how it is calculated, as well as what traders can look for when utilizing this popular technical indicator. Keep reading to find out more!
What is Relative Strength Index (RSI)?
Relative strength index (RSI) is a technical indicator used in the analysis of financial markets to measure the relative strength (or momentum) of a security. It’s based on the idea that the strength of a stock or other instrument can be measured by comparing its recent performance with its past performance.
The RSI is a popular oscillator indicator that measures the speed and magnitude of price movements for a given period of time, usually 14-days. The RSI is calculated using the formula mentioned below.
How Is Relative Strength Index (RSI) Calculated?
The RSI is calculated using a 14-day period, which can be adjusted to anywhere from two to 14-days. Depending on the time-frames of the analysis one is utilizing, the RSI can be calculated either on a daily basis or longer time-frames such as weekly or monthly.
RSI formulas typically use the following calculations.
• An average of up days is calculated by adding all positive price change values over a given look-back period and then dividing the total by the same look-back period, which is typically 14.
• An average of down days is calculated in a similar manner, with all negative price variations added together and then divided by the same look-back period.
• The relative strength index is then calculated by dividing the average of up days (the numerator) by the average of down days (the denominator). The resulting value is then multiplied by 100 to create a relative strength index from a value range of 0 to 100.
RSI Calculation Example:
Let’s take a look at an example of how a 14-day RSI would be calculated.
• Assume that over a 14-day period, the following Closing prices for a stock were observed: 63, 62, 61, 65, 77, 77, 78, 75, 72, 69, 68, 71, 73, and 79.
• The “up days” are calculated by taking the difference between the closing price and the day’s price before, and if the difference is greater than 0, it is considered to be an up day.
• In the above example, there are seven up days and seven down days.
• The average of up days is calculated by summing together all of the up days and dividing that number by seven. Similarly, the average of down days is calculated by summing all of the down days and dividing the result by seven.
• Once these two values have been calculated, they are plugged into the RSI formula.
• Finally, the RSI is calculated by dividing the average of up days (the numerator) by the average of down days (the denominator). This result is then multiplied by 100 to get an RSI range of 0 to 100.
Understanding RSI Levels
The RSI oscillates between zero and 100, indicating whether a stock is overbought or oversold. Generally, stocks with a RSI value above 70 are considered overbought and stocks with a RSI value below 30 are considered oversold.
Overbought stocks are those that have recently gone up in price much faster than the overall market and are likely to reverse soon. Oversold stocks are those that have gone down in price much faster than the overall market and could be a good opportunity for a bargain.
Traders use the RSI as an indication of when to buy and sell stocks, as it helps to identify potential turning points in the stock’s price. The RSI can also be used in combination with other technical indicators to get a better overall view of the market.
Trading Strategies Using Relative Strength Index (RSI)
When trading stocks, investors often use RSI as an indicator to get a better overall read of the market and in order to identify potential trading opportunities. Take a look at some of the potential trading strategies investors can use when employing the RSI.
• Overbought/Oversold: As mentioned earlier, stocks are considered to be overbought when they have a RSI value above 70 and oversold when they have a RSI value below 30. Traders often use this as a signal to get into a trade by buying when the RSI is below 30 and selling when the RSI is above 70.
• RSI Divergence: RSI divergence is one of the most powerful signals when trading with the RSI. It is when the stock’s price and the RSI are moving in opposite directions, indicating that a reversal may be imminent.
• RSI Golden Cross: The RSI Golden Cross is a signal that occurs when the RSI is crossing above 50. It indicates that the trend is changing from bearish to bullish and can be used to get into a trade.
• RSI Death Cross: The RSI Death Cross is the opposite of the RSI Golden Cross and is when the RSI is crossing below 50. It indicates that the trend is changing from bullish to bearish and can be used to get out of a long position or enter a short position.
The relative strength index (RSI) is an oscillator-type technical indicator that is used to measure the speed and magnitude of a stock’s price movements. RSI is calculated by dividing the average of up days (the numerator) by the average of down days (the denominator). Traders use the RSI as an indication of when to buy and sell stocks, as it helps to identify potential turning points in the stock’s price. There are several different strategies that traders can use when employing the RSI, such as overbought/oversold levels, RSI divergence, the RSI Golden Cross, and the RSI Death Cross. It is always important to be aware of the potential risks involved when trading stocks and to employ strict risk management when trading with the RSI.
