Relative Strength Index (RSI) – A Beginner’s Guide

Relative Strength Index (RSI)

Summary

 It was built by renowned J.Welles Wilder, a former mechanical engineer who later became a technical analyst. The Relative Strength Index (RSI) is a widely recognized and generally used momentum oscillator. RSI determines the price momentum of a stock or other investment products. The RSI’s central objective is to detect how rapidly traders are raising or lowering a security’s price.

Typically, traders observe this oscillator’s readings for three weeks. The momentum oscillator, known as the RSI, oscillates between 0 and 100. Readings of 30 or below often signal oversold market conditions and a higher probability of price rising. Some dealers view an oversold currency pair as a sign that the downward trend will likely change, providing a buying chance.

On the other hand, Readings of 70 or above signal overbought circumstances and raise the likelihood that prices may drop. Some dealers view an overbought forex currency pair as a sign that the upward trend is likely to change, providing a market selling chance. There are various ways to use RSI, which helps traders adapt their trading approach as necessary. Therefore, RSI should be a part of any technical trader’s toolkit, even for those just starting. The relative strength index has gained fame as a momentum oscillator since its launch in 1978.

The formula for the Relative Strength Index

 There are two steps in the calculation of the relative strength index (RSI) with the help of the following formula:

RSI = 100 – [100 / (1 + (Average of Upward Price Change/Average of Downward Price Change)]]  

The RSI helps investors identify whether an asset is excessively overbought or oversold in relation to current price levels. Its calculation uses the typical price gains and losses over a certain time period.

Importance of RSI

Dealers may use a relative strength index to forecast a security’s price trend. It can aid dealers in finding patterns and trend reversals. This indicator may alert dealers about overbought and oversold assets as well as give buy and sell signals for short-term investors. It is a technical indicator that supports trading techniques when combined with others.

Pros and Cons of Relative Strength Index (RSI)

Some pros of the Relative strength index are as follows:

• It uses an easy mathematical formula, and its calculation is simple enough for traders to perform by hand if required.
• It provides a simple chart analysis. Even new traders may easily use this indicator since its overbought and oversold levels are properly defined. However, it is yet reliable and informative enough for seasoned traders to continue to use it.
• Consequently, the RSI is most helpful when an asset price fluctuates between bullish and bearish oscillations.

 Some Cons of the Relative strength index are as follows:

• Real reversal indications are rare and challenging to distinguish from false reports.
• When an asset has strong momentum in any direction, the RSI, which shows momentum, can be overbought or oversold for a very long period.
• Strong currency trends may cause RSI to decrease its accuracy. RSI needs highly cautious attention, even if strong trends may still make it useful.