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Technical Studies: Relative Strength Index (RSI)

RSI is an oscillator that measures a security's internal strength. This momentum indicator weighs the security's recent gains against its recent losses, plotting the results on a 0-100 scale. A reading of 70 (80 in a raging bull market) indicates an overbought condition and a reading of 30 (20 in a declining bear market) indicates an oversold condition. An overbought level may indicate that a price decline is likely while an oversold level may indicate that a price rise is likely.

Customizing RSI: The default RSI setting is 14 periods (minutes/hours/days/weeks/months, based on the frequency selected). To change the settings, click the Edit button in the legend, then specify a period in the resulting text box. Shorter time periods produce more volatile RSI readings. A nine-period RSI will generate overbought and oversold signals much more quickly than a 21-period RSI.

How RSI is calculated: Here are the various steps (note that n is the number of periods for which the RSI is calculated):
First RS = Average Gain / Average Loss
where Average Gain = (Sum of all gains from previous day's close / n)
and Average Loss = (Sum of all losses from the previous day's close / n)

The First RS is the initial relative strength used in the RSI calculation. Note that the Average Gain and the Average Loss are misnomers, as the Total Gains or Total Losses, respectively, are divided by the number of periods in the RSI rather than the number of gains or losses for the period.

When the First RS is known, the first RSI point can be plotted:
RSI = 100 - (100 / 1 + RS)

Going forward, the Smoothed RS (rather than the First RS) is used:

Smoothed RS =[previous Average Gain × (n-1) + Current Gain / n]
[previous Average Loss × (n-1) + Current Loss / n]

The Smoothed RS is then included in the calculation of the RSI line.

Each day's gain or loss determines the direction and slope of the RSI line. The above calculation implies that it takes strong and consistent price movement to push the RSI line beyond the overbought/oversold indicators, and continued strong movement to keep it there. As the price weakens or strengthens at the 70/30 levels, respectively, the changing slope and direction of the RSI may signal trend reversals.

 
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