RELATIVE STRENGTH INDEX (RSI)
RSI is a price following oscillator, whose value oscillates between 0-100 and calculated based on relative strength. It is a measure of momentum. An N-period relative strength is the ratio of gains in the price in last N days, divided by the losses in last N days.
Calculations:
RSI = (100 – (100 / (1 + RS)))
RS = (14 EMA on the last 14 up bars) / (14 EMA on the last 14 down bars)
RSI formula using the default 14-period
When to use…
Ranging Markets
Set the Overbought level at 70 and Oversold at 30.
• Go long when RSI falls below the 30 level and rises back above it
or on a bullish divergence where the first trough is below 30.
• Go short when RSI rises above the 70 level and falls back below it
or on a bearish divergence where the first peak is above 70.
Failure swings strengthen other signals.
Trending Markets
Only take signals in the direction of the trend.
• Go long, in an up-trend, when RSI falls below 40 and rises back above it.
• Go short, in a down-trend, when RSI rises above 60 and falls back below it.
Exit using a trend indicator.
While you can use the RSI as an overbought and oversold indicator, it works best when a failure swing occurs between the RSI and market prices. For example, the market makes new highs after a bull market setback, but the RSI fails to exceed its previous highs.
Another use of the RSI is divergence. Market prices continue to move higher/lower while the RSI fails to move higher/lower during the same time period. Divergence may occur in a few trading intervals, but true divergence usually requires a lengthy time frame, perhaps as much as 20 to 60 trading intervals.
