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Relative Strength Index (RSI)

RSI measures the strength or weakness of recent activity relative to historical activity for a particular stock or index. The RSI is an oscillator. Its value swings between an upper limit and a lower limit. RSI is calculated using an exponential moving average of the upward price movements divided by the downward price movements over a particular time interval, such as 14 days.

The RSI can identify overbought or oversold conditions when the buying momentum changes. The RSI will range from 0 to 100. Values above 50 are generally considered bullish and values below 50 are generally considered bearish. When the RSI rises above 70 or 80 (in a bull market), it is considered overbought and a bearish sell signal is generated when it reverses. When the RSI falls below 30 or 20 (in a bear market), it is considered oversold and a bullish buy signal is generated when it reverses.

As with a stock, a series of higher highs and higher lows on the RSI indicates a continued bullish trend. Similarly, a series of lower lows and lower highs indicates a continuing bear trend.

When the RSI indicates that the stock is overbought, it will top out ahead of a market price top. When the RSI indicates that the stock is oversold, it will bottom out ahead of a market price bottom. Thus RSI is a good lead indicator of a likely trend reversal.

RSI = 100 - [100/(1 + RS)]
  where:
    RS = AG/AL
    AG = Average gain of upward price moves over RSI period of n days
    AL = Average loss of downward price moves over RSI period of n days
    n= days (many analysts use 9 - 15 day RSI)

Small n makes the RSI more volatile, making it hit extremes more often. Large n makes the RSI less volatile, making it less likely to hit extremes.

Projections using RSI are made more meaningful if you do backtesting with a particular stock to see what the RSI levels were when the stock price made reversals.

The RSI is frequently used by momentum traders.




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