What is RSI?
Relative strength index or RSI is a momentum-based oscillator, which is used to measure the speed (velocity) as well as change (magnitude) of directional price movements that give a clear measure of the strength of a trend. The RSI indicates whether the asset is in an oversold or overbought territory.
The RSI is displayed as an oscillator (a line graph that moves between two extremes) which ranges between 0 to 100. The term “Relative Strength Index” unlike the name suggests does not compare the relative strength of different securities, but instead shows the price movement of the securities.
The Formula for RSI
The relative strength index (RSI) formula consist of two parts :
RSI = 100- 100/(1+RS)
Where RS is AVERAGE GAIN/ AVERAGE LOSS
RSI consist of the following basic components: RS, Average Gain and Average Loss. This RSI calculation is based on 14 periods. Losses are expressed as positive values, not negative values.
The very first calculations for average gain and average loss are simple 14-period averages:
First Average Gain = Sum of Gains over the past 14 periods / 14.
First Average Loss = Sum of Losses over the past 14 periods / 14
The second part of the calculations are based on the prior averages and the current gain loss:
Average Gain = [(previous Average Gain) x 13 + current Gain] / 14.
Average Loss = [(previous Average Loss) x 13 + current Loss] / 14.
Let’s understand Relative Strength Index by way of an example:
Assume that the following data belongs to XYZ company:
|
No of Periods |
Closing Price |
%gain |
%loss |
|
1 |
46 |
|
|
|
2 |
47 |
2.17 |
|
|
3 |
47.5 |
1.06 |
|
|
4 |
46.25 |
|
2.63 |
|
5 |
46.5 |
0.54 |
|
|
6 |
48 |
3.22 |
|
|
7 |
49 |
2.08 |
|
|
8 |
48.25 |
|
1.53 |
|
9 |
50 |
3.62 |
|
|
10 |
50.25 |
0.5 |
|
|
11 |
49.75 |
|
.99 |
|
12 |
48 |
|
3.51 |
|
13 |
47 |
|
2.08 |
|
14 |
47.5 |
1.06 |
|
|
15 |
46 |
|
3.15 |
|
TOTAL |
|
14.25 |
13.89 |
FIRST RS= AVERAGE GAIN/ AVERAGE LOSS
= (14.25/14)/ (13.89/14)
=1.071/0.99
= 1.081
RSI= 100- 100/1+RS
= 51.94
As we can see the calculation of RSI is fairly simple. The objective of using RSI is to help the trader identify oversold and overbought territory. An overbought stock means expert thinks that it's selling for more than it's actually worth. On the other hand, an oversold stock is one that is trading below what it is really worth.
