Understanding the Relative Strength Index (RSI)

Joseph Liebreich
DataDrivenInvestor
Published in
3 min readFeb 16, 2021

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Can this index help you analyze stock price movements?

Picture via Wikipedia.org

Momentum Oscillators

The Relative Strength Index (RSI) is classified as a momentum oscillator. Momentum in one word means speed as in the airplane gathered momentum as it taxied down the tarmac. But that’s not the whole story. Momentum also implies power. So compare a car going 95 miles per hour to a fast ball thrown at 95 miles per hour. The car has more momentum (power) than the baseball. So we not only have the speed but the size of the push behind the speed.

An oscillator, in stock market analysis, rises and falls between two set values. As the oscillator rises and touches or penetrates an upper limit, this indicates to the technician that the stock is overbought — too many buyers and not enough sellers. When the oscillator approaches, touches and goes through the lower limit, the reverse is true — sellers exceed buyers and the stock is oversold.

The Relative Strength Index

The RSI, as a momentum oscillator, measures the speed and the power of price movements. It does this by measuring the ratio of higher closing prices to lower closing prices. As this ratio is tracked, stocks with higher ratios are stronger than stocks with lower ratios. Usually the RSI is based on a 14-day unit, and it is measured on a scale of 0 to 100. Indicator levels are typically 70 and 30. These values are up to individual investors to assign.

Development and Use of the RSI

The RSI was originally outlined by J. Wells Wilder in his book, New Concepts in Technical Trading Systems. Realizing that when a price moves up rapidly, sooner or later it’s going to drop back, Wilder tried to come up with a method that would signal when that turning point was about to happen. And, of course, the reverse could also be a profitable event. A sagging stock price would presumably eventually turn around and go up.

Wilder developed the RSI to measure a stock price’s recent trading strength. The slope of the RSI would show how fast the trend was changing. Also disagreement (he called it divergence) between the RSI and the movement of the price he felt was a strong indicator of a market turning point. So…

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Been writing articles here and there for 15 years. I like to write about a variety of topics.