# Relative Strength Index

June 02, 2021

**Relative Strength Index**

**DEFINITION:
**

Relative Strength Index (acronym
RSI) is one of the most extensively used momentum oscillators in the realm of
technical analysis of stocks. It was introduced by Welles Wilder in June 1978
and its computation is explained in detail in his book New Concepts in
Technical Trading System. Momentum oscillator measures the velocity and
magnitude of price movements of a security. RSI compares the magnitude of
average gains and average losses of a security for drawing inferences about its
strength and weakness over a predetermined time period.

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**DESCRIPTION:
**

Relative Strength is computed
using the formula

RSI = 100 – (100/1+RS)

RS (Relative Strength) = Average
of X days up closes / Average of X days down closes

Wilder used the 14-day RSI, which
is still the most commonly used RSI. However, an analyst is free to decide the
number of days for computing the same.

For example, during a 14-day
trading period assume that a security has generated positive returns on 9 days
and negative returns on 5 days. In this case, the Relative Strength Index is
calculated as follows

1. Calculate the absolute gain in
each of the 9 up days. Add the absolute gain of each day and divide by 14. This
will give the figure of average up closes.

2. Calculate the absolute loss in
each of the 5 days. Add the absolute loss of each day and divide by 14. This
will give the figure of average down closes.

3. Dividing the average up closes
or gains by the average down closes or losses gives us the Relative Strength.

4. The figure is further
normalized using the above formula so as to ensure that it lies between 0 and
100.

For
computing the next RSI, the following steps are followed

1. For calculating the next
average gains, multiply the previous average gains by 13 and add today’s gains
if any and divide the result by 14. In our previous example, we will multiply
the average absolute gains of 9 days and add today’s absolute gain (if any) and
divide the result by 14.

2. For calculating the next
average losses, multiply the previous average losses by 13 and add today’s loss
if any and divide the result by 14. In our example, we will multiply the
average absolute losses of 5 days and add today’s absolute loss (if any) and
divide by 14.

3. The next step involves
dividing the average gains by the average losses for getting the figure of
Relative Strength.

4. Finally, the RSI is found
using the formula RSI = 100 – (100/1+RS)

The
following inferences can be drawn from Relative Strength Index

1. Overbought and Oversold
levels: RSI gives an indication of the impending reversals or reaction in price
of a security. RSI moves in the range of 0 and 100. So an RSI of 0 means that
the stock price has fallen in all of the 14 trading days. Similarly, an RSI of
100 means that the stock price has risen in all of the 14 trading days. In
technical analysis, an RSI of above 70 is considered an overbought area while
an RSI of less than 30 is considered as an oversold area. RSI can be used as a
leading indicator as it normally tops and bottoms ahead of the market, thereby
indicating an imminent correction in the price of a security. It is pertinent
to note that the levels of 70 and 30 needs to be adjusted according to the
inherent volatility of the security in question.

2. Failure Swings: This is also
called support and resistance penetrations or breakouts. Failure swings are
indications of impending market reversals.

** **

**Bearish Failure
Swing**

In this chart, the RSI touches the 70 marks, the threshold of overbought zone then falls to 60. This is called the failure point. Post that, it moves again but rises less than the previous high of 70, thereby, creating a failure swing. It then falls below the failure point there creating a bearish failure swing. It acts as a signal for the trader to go for a short position in the security.

**Bearish Failure Swing**

In this chart, the RSI touches the 30 marks,
the threshold of oversold zone and then rises to 40, the failure point. It then
falls again but the fall is lower than the previous value of 30. Moreover, the
RSI crosses the failure point to rise even higher thereby creating a bullish
failure swing. It acts as a signal for a trader to go for a long position in
the security.

**1.
****Divergence: **

Divergence
results when the price of a security and the RSI behave differently. If the
security price is decreasing or flat but RSI is increasing, it’s a sign of
divergence. Similarly, when the security price is increasing or flat by RSI is
falling, it’s a sign of divergence. It is a strong indication of an imminent
market correction.

2. **Support and
Resistance:**

In some
situations, the RSI exhibits support and resistance levels with more clarity
than the security price itself.

The
14-day RSI of stock prices of Reliance Power in NSE. The overbought level set
at over 70 and oversold level set at below 30.

According to Wilder, the RSI used together with
bar chart can provide pivotal inputs to an analyst for drawing inferences from
a chart.

Source: https://economictimes.indiatimes.com/definition/relative-strength-index

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