The Relative Strength Index (RSI) is an oscillator first introduced in 1978 by Welles Wilder in Commodities (now Futures) Magazine. The RSI compares the magnitude of a stock's recent gains to the magnitude of its recent losses on a scale from 0 to 100.
When using the RSI as an overbought/oversold indicator, Wilder recommended using levels of 70 or more as overbought and 30 and and below as oversold. Generally, if the RSI rises above 30 it is considered bullish for the underlying stock. Conversely, if the RSI falls below 70, it is a bearish signal.
Another method of analyzing the RSI is to look for a divergence. If the security is making a new highs and yet the RSI fails to surpass its previous high, this 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." This serves as a confirmation of the impending reversal.
While the RSI is calculated using a fairly simple formula, it may be wise to refer to Wilder's New Concepts in Technical Trading Systems for a more complete discussion. The basic formula for the RSI is:
Where:
U=An average of upward price change
D=An average of downward price change
Information provided by John Murphy, author of Technical Analysis of the Financial Markets and The Visual Investor.
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