What is the Relative Strength Index (RSI) and How Is It Used?
The Relative Strength Index (RSI) is a momentum technical analysis indicator that examines the buying and selling movements of a financial asset. The RSI is used to determine whether an asset is overbought or oversold. RSI is a value that ranges from 0 to 100. Generally, if the RSI value is above 70, the asset is in the overbought region, and below 30, the asset is in the oversold region.
How is the RSI calculated?
The RSI is calculated by comparing the average bullish and bearish movements of the asset over a given time period. For example, the 14-day RSI looks at the closing prices of the last 14 days. For each day, an upward movement is recorded if the price is higher than the previous day, and a downward movement if it is lower. Then the average of the last 14 days' bullish movements is taken and this value is called U. Similarly, the bearish movements of the last 14 days are averaged and this value is called D. Finally, the RSI value is calculated by the formula:
RSI = 100 - (100 / (1 + U / D))
How is the RSI interpreted?
RSI is a versatile indicator that can be used as a trend follower or oscillator. To follow the trend, the RSI crossing the 50 level indicates the direction of the trend. For example, an uptrend may have started when the RSI rises above 50, and a downtrend when it falls below 50. For use as an oscillator, the RSI entering overbought or oversold zones indicates that price may move in the opposite direction. For example, it is thought that the price may fall when the RSI rises above 70, and rise when it falls below 30.
What are the advantages and disadvantages of RSI?
The advantages of RSI are:
- It is a simple and easy to understand indicator.
- Indicates the strength and weakness of price movements.
- Generates signals for trend reversals and continuations.
- Available for different time periods and assets.
The disadvantages of RSI are:
- It may give false signals. Especially in strong trends, the RSI can stay in the overbought or oversold zone for a long time and the price can continue the trend.
- It is sensitive to volatility. When price movements are too strong, the RSI value can change very quickly and reduce the signal quality.
- It may not be enough on its own. Using RSI together with other technical analysis tools can yield healthier results.