| RSI (Relative Strength Index) |
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Formula
The way to calculate the RSI indicator is as follows:  100
[1 + (average upward price change - average downward price change)] Interpretation of the Relative Strength Index J. Wells Wilder, in his book New Concepts in Trading Systems (Greensboro, NC: Trend Research, 1978), points out some specific configurations that the RSI is likely to make during certain market conditions. He believes that these configurations or patterns are likely finger prints at the scene of a crime, serving as unquestionable evidence that the market will change in a predictable fashion. For example, look for a divergence in the RSI when trying to identify the internal strength or weakness of a trend. If the commodity or stock researches a new high but then RSI fails to follow suit, a reversal may be around the corner. In such situations, look for the candlestick patterns that also foretell reversal, such as harami and engulfing bullish patterns. Stars, doji, hammers and hangmen can also be significant reversal indicators. If this divergence were to continue, it could lead to a market contingency known as a failure swing, in which the RSI line turns down (after not taking out its previous high) and falls below its most recent channel. If you are anticipating a bearish reversal in an over bought market, look for candlestick combination patterns such as piercing lines or an engulfing pattern with a doji, hammer, inverted hammer, or any long white bozu line (marubozu, opening bozu, and closing bozu). The most prevalent use of this indicator is as an oscillator to determine if a stock or commodity is currently over bought or over sold. When the RSI rises above 70%, it signal top; inversely, when the RSI falls below above 30%, it signals a bottom. The RSI should be used to define support and resistance levels. Also, Wilder suggests looking at the RSI for pattern formations in the same way that you would look at a bar or candlestick chart. When using the relative strength index, always remember that it is designed to show the relative change of the strength and direction of a trend. As long as the RSI and the underlining market value are moving higher or lower in unison, they have the strength and capability to maintain the rally and make new high's or lows. The RSI will indicate a weakening trend, or exhaustion, when the market might not be able to sustain a bearish or bullish rally. |
 
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Click Here to Enlarge »Convergence between the RSI and price can mean that a change in a down trend is approaching. By drawing a resistance line above the current trend, if this change in trend occurs you can receive an immediate alert when the trend line is broken. RSI indicator and price diverging (moving apart) zoom » Divergence between the RSI and the price can mean that a change in an up trend is approaching. By drawing a support trend line underneath the current trend, if this change in trend occurs you can receive an immediate alert when the trend line is broken. |
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