relative strength index definition

Chart 9 shows 14-week RSI for SPY during the bull market from 2003 until 2007. RSI surged above 70 in late 2003 and then moved into its bull market range (40-90). There was one overshoot below 40 in July 2004, but RSI held the zone at least five times from January 2005 until October 2007 (green arrows). In fact, notice that pullbacks to this zone provided low risk entry points to participate in the uptrend. Wilder’s formula normalizes RS and turns it into an oscillator that fluctuates between zero and 100. The normalization step makes it easier to identify extremes because RSI is range-bound.

  • The MACD is calculated by subtracting the 26-period exponential moving average (EMA) from the 12-period EMA.
  • Using the RSI in this way is very similar to drawing trend lines on a price chart.
  • Traders will often place this RSI chart below the price chart for the security, so they can compare its recent momentum against its market price.
  • In this case, we can see that a trader chooses to exit the trade at the first sign of a trend reversal to avoid risks.

If the RSI forms in the overbought zone and a Failure Swing pattern occurs, it could be a signal to sell or go short. Conversely, if the RSI is in the oversold zone and a Failure Swing pattern forms, it could be a signal to buy or go long. However, it’s important to use additional indicators to confirm these signals and to pay attention to the trend of the relative strength index definition market as a whole. For example, if the RSI hasn’t entered the oversold territory in the past three months, you can set a custom overbought level, say 76, on your trading chart timeframe. You can then enter trades based on the same principle of waiting for the RSI to break through the strong level when it goes outside the overbought or oversold levels.

RSI breakdown/breakout strategy

A variation called Cutler’s RSI is based on a simple moving average of U and D,[7] instead of the exponential average above. Cutler had found that since Wilder used a smoothed moving average to calculate RSI, the value of Wilder’s RSI depended upon where in the data file his calculations started. Cutler’s RSI is not data length dependent, and returns consistent results regardless of the length of, or the starting point within a data file.

  • A Value-Added Tax (VAT) is a type of tax applied at every step of a product’s supply chain, provided that the company has added value to increase the product’s price.
  • It is a versatile technical analysis tool and is most effective when combined with another method.
  • Most traders take this as a signal to buy because selling momentum is slowing and the price will likely climb.
  • The RSI measures both the speed and rate of change in price movements within the market.
  • This will help to increase or decrease the number of buy and sell signals.

A bearish divergence is when RSI makes a lower high while the price makes a higher high. Unfortunately, accurate reversal signals are rare and can be challenging to separate from false alarms. In Technical Analysis for the Trading Professional, Constance Brown suggests that oscillators do not travel between 0 and 100. RSI tends to fluctuate between 40 and 90 in a bull market (uptrend) with the zones acting as support. These ranges may vary depending on RSI parameters, strength of trend and volatility of the underlying security.

Volume Weighted Average Price (VWAP)

This RSI calculation is based on 14 periods, the default Wilder suggested in his book. The RSI shows a potential buy signal when the RSI crosses and moves above the oversold line (30). The RSI shows a potential sell signal when the RSI crosses below the overbought line (70). If the relative strength index is below 50, it generally means that the stock’s losses are greater than the gains.

Divergence occurs when momentum is moving in one direction, but prices are moving in another. In this scenario, prices would continue to slide or rally, but the RSI would fail to confirm that momentum is increasing in the direction of the trend. Decelerating momentum could indicate that the trend is about to consolidate. Learn how the RSI is calculated and how this type of trading indicator​ can be used within the financial markets.

Average Directional Index (ADX indicator)

Style refers to the appearance of the RSI indicator on your chart. You can customize the thickness and color of the RSI line, as well as the levels and the fill color between the levels. In theory, the crossover strategy could prevent a trader from purchasing when the market is diving and selling on a sharp rally. Traders would want to avoid a situation where they are buying when the RSI hits 30, just to see the RSI then tumble to 10. We have long understood that using a sole indicator as the basis for your trading decisions can be disastrous if we fail to read or there is a false signal generated by the indicator.

A false negative would be a situation where there is a bearish crossover, yet the stock suddenly accelerated upward. However, they measure different factors, so they sometimes give contradictory indications. For example, the RSI may show a reading above 70 for a sustained period of time, indicating a security is overextended on the buy side. The MACD measures the relationship between two EMAs, while the RSI measures price change momentum in relation to recent price highs and lows. These two indicators are often used together to provide analysts with a more complete technical picture of a market.