The relative strength index (RSI) indicator is a technical analysis tool that measures the speed of a recent price movement of stocks, indices and exchange-traded funds (ETFs). It is a momentum oscillator for day trading and intraday trading that can be used to highlight overbought and oversold conditions in the equity markets.
Typically, the RSI is displayed as a line graph on a scale of zero to 100. In an RSI trading scenario, traders tend to use readings of 70 or above to indicate that the market prices are significantly high (overbought condition), on the other hand, a reading of 30 or below points highlights that they are considerably low (oversold condition).
Generally, short-term traders regard the RSI line moving lower than the overbought line or higher than the oversold line as buy or sell signals.
The RSI is calculated using a formula that compares recent gains and losses to highlight the uptrend (bull market) or downtrend (bear market) market conditions. The RSI usually considers a 14-day timeframe.
The formula for RSI takes into consideration two equations. First, the relative strength (RS) is calculated by dividing the average gain by the average loss.
Then, the second calculation is made using the following formula: RSI=100-(100/(1+RS)).
For instance, during a 14-day trading period, let’s say, stock XYZ generated positive returns on nine days with an average gain of 3% and negative returns on five days with an average range of 2%. Now, consider the equations with these numbers for the calculation of RSI:
Traders tend to use RSI to predict the price behaviour of an asset. It also helps them understand buy or sell signals in the market. Generally, traders tend to develop a trading strategy based on RSI readings along with other technical analysis tools.
Rajiv is an independent editorial consultant for the last decade. Prior to this, he worked as a full-time journalist associated with various prominent print media houses. In his spare time, he loves to paint on canvas.