The Relative Strength Index Explained
The Relative Strength Index (RSI) is one of the most popular overbought/oversold (OB/OS) indicators. The RSI was developed in 1978 by Welles Wilder.
The name "Relative Strength Index" is slightly misleading, as the RSI does not compare the relative strength of two securities, but rather the internal strength of a single security. The RSI is basically an internal strength index and is adjusted on a daily basis by the amount by which the market rose or fell. A high RSI occurs when the market has been rallying sharply and a low RSI occurs when the market has been selling off sharply.
One characteristic of the RSI is that it moves slower when it reaches overbought or oversold conditions, and then snaps back very quickly when the market enters even a mild correction. This brings the RSI back to more neutral levels and indicates that the price trend may be able to resume.
When Wilder introduced the RSI, he recommended using a 14-day RSI. Since then, the 9-day and 25-day RSIs have also gained popularity. The fewer days used to calculate the RSI, the more volatile the indicator.
The RSI is a price-following oscillator that ranges between 0 and 100. A popular method of analyzing the RSI is to look for a divergence in which the security is making a new high, but the RSI is failing to surpass its previous high. This divergence is an indication of an impending reversal. When the RSI then turns down and falls below its most recent trough, it is said to have completed a "failure swing." The failure swing is considered a confirmation of the impending reversal.
The formula for the RSI:
A= An average of upward price change
B= An average of downward price change