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RELATIVE STRENGTH INDEX (RSI)
Doug Schaff
FX-Strategy
| Characteristic: | Price Breakout Indicator | |
| Parameter Defaults: | Length | 10 controls the measurement period for the channel |
| Plots: | Upper | |
RSI is a popular indicator commonly used to confirm price movement and help identify turning points in the market. It was created by Welles Wilder Jr.
The RSI calculates a value based on the cumulative strength and weakness of price over a specified period. For that period, RSI accumulates the points gained on periods with higher closes and the points lost on periods with lower closes. The sum of number of the points gained is divided by the sum of the points lost and this is normalized between 0 to 100. The direction of RSI is considered to confirm price movement, i.e. a rising RSI confirms rising prices.
| The formula is: | RSI = 100 - | ( 100 ) |
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| ( 1 + RS ) |
| where: | RS = | Sum of positive closes |
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| Sum of negative closes |
RSI has traditionally been used to help identify turning points in two ways:
In consolidation periods when RSI reaches above 70 (overbought) or below 30 (oversold)
The chart above shows how well RSI can be used to identify overbought and oversold conditions in a consolidating market as the value reached above 70 and below 30.
When there are non-confirmations or divergences. For example, a new price high without a new high in RSI or in the case of a new price low without a new low in RSI may indicate a false breakout.
In the chart above it can be seen that at the end of the downtrend in price with successive lower lows, RSI failed to confirm the price lows, registering higher troughs in the RSI value. This is a bullish divergence. Then, after price had reversed higher, the opposite occurred. While price confirmed an uptrend through successive higher highs, RSI failed to confirm those price highs.
