The Relative Strength Index (RSI) is a popular technical analysis indicator used to measure the strength and momentum of a financial instrument, such as a stock or a market index. It was developed by J. Welles Wilder and introduced in his book "New Concepts in Technical Trading Systems" in 1978.
The RSI is a bounded oscillator that ranges between 0 and 100. It is typically displayed as a line chart that fluctuates between these two extremes. The RSI is calculated using the average gains and losses of a specified period, usually 14 days, although other timeframes can be used as well.
The formula to calculate the RSI involves the following steps:
Calculate the average gain (AG) and average loss (AL) over the specified period.
Average Gain (AG) = Sum of gains over the period / Number of periodsAverage Loss (AL) = Sum of losses over the period / Number of periods
Calculate the relative strength (RS), which is the ratio of the average gain to the average loss.
RS = AG / AL
Calculate the RSI using the formula:
RSI = 100 - (100 / (1 + RS))
The RSI is considered an oscillator because it fluctuates between overbought and oversold levels. Typically, a reading above 70 is considered overbought, suggesting that the instrument may be due for a price correction or a reversal. Conversely, a reading below 30 is considered oversold, indicating that the instrument may be undervalued and due for a potential price rebound.
Traders and analysts use the RSI to identify potential entry or exit points in the market. For example, when the RSI crosses above the 30 level from below, it may be viewed as a bullish signal, indicating a potential buying opportunity. Conversely, when the RSI crosses below the 70 level from above, it may be seen as a bearish signal, suggesting a potential selling opportunity.
It's important to note that while the RSI can provide valuable insights into market conditions, it is just one tool among many in technical analysis. It should be used in conjunction with other indicators and analysis techniques to make well-informed trading decisions.
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