How to Use Relative Strength Index-RSI

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INO.com INO TV Traders Blog Tuesday, January 3rd 2012 11:34am EST

Lesson 6

Ho to Use the Relatie Strength Inde

One of the most useful tools employed by many technical commodity traders is a momentum oscillator which measures the

velocity of directional price movement.

When prices move up very rapidly, at some point the commodity is considered overbought; when they move down very

rapidly, the commodity is considered oversold at some point. In either case, a reaction or reversal is imminent. The slope of

the momentum oscillator is directly proportional to the velocity of the move, and the distance traveled up or down by this

oscillator is proportional to the magnitude of the move.

The momentum oscillator is usually characterized by a line on a chart drawn in two dimensions. The vertical axis represents

magnitude or distance the indicator moves; the horizontal axis represents time. Such a momentum oscillator moves very

rapidly at market turning points and then tends to slow down as the market continues the directional move. Suppose we are

using closing prices to calculate the oscillator and the price is moving up daily by exactly the same increment from close to

close. At some point, the oscillator begins to flatten out and eventually becomes a horizontal line. If the price begins to levelout, the oscillator will begin to descend.

Ploing he ocillao

Let's look at this concept using a simple oscillator expressed in terms of the price today minus the price "x" number of days

ago - let's say 10 days ago, for example.

The easiest way to illustrate the interaction between price movement and oscillator movement is to take a straight line price

relationship and plot the oscillator points used on this relationship, as shown in this chart:


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In o illaion, e begin on Da 10 hen he cloing pice i 48.50. The pice 10 da ago on Da 1 i 50.75. So ih a

10-da ocillao, oda' pice of 48.50 baced fom he pice 10 da ago of 50.75 el in an ocillao ale of -

2.25, hich i ploed belo he eo line. B folloing hi pocede each da, e deelop an ocillao ce.

The ocillao ce deeloped b ing hi hpoheical iaion i e ineeing. A he pice moe don b he ame

incemen each da beeen Da 10 and 14, he ocillao ce i a hoional line. On Da 15, he pice n p b 25

poin, e he ocillao n p b 50 poin. The ocillao i going p ice a fa a he pice. The ocillao conine

hi ae of moemen nil Da 23 hen i ale become conan, alhogh he pice conine o moe p a he ame

ae.

On Da 29, anohe e ineeing hing happen. The pice leel o a 51.00, e he ocillao begin o go don. If he

pice conine o moe hoionall, he ocillao ill conine o decend nil he 10h da, a hich ime boh he

ocillao and he pice ill be moing hoionall

Noe he ineacion of he ocillao ce and he pice ce. The ocillao appea o be one ep ahead of he pice.

Tha' becae he ocillao, in effec, i meaing he ae of change of pice moemen. Beeen Da 14 and 23, he

ocillao ho he ae of pice change i e fa becae he diecion of he pice i changing fom don o p. Once

he pice ha boomed o and aed p, hen he ae of change lo don becae he incemen of change ae

meaed in one diecion onl.

Thee poblem

The ocillao can be an ecellen echnical ool fo he ade ho ndeand i inheen chaaceiic. Hoee, hee

ae hee poblem enconeed in deeloping a meaningfl ocillao:

1. Eaic moemen ihin he geneal ocillao configaion. Sppoe ha 10 da ago he pice moed

limi don fom he peio da.No, ppoe ha oda he pice cloed he ame a eeda. When o

bac he pice 10 da ago fom oda' pice, o ge an eoneol high ale fo he ocillao oda.

To oecome hi, hee m be ome a o dampen o mooh o he eeme poin ed o calclae he


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.

2. T . H ,

? T . T ,

.

3. C . T .

A R S I (RSI):

RSI = 100 - [100 / (1 + RS)]

RS = A 14 ' UP / A 14 ' DOWN

F R S I (RSI), 14 . F

, ' . T RSI :

O UP 14 14. T UP .

O DOWN 14 14. T

DOWN .

D UP DOWN . T R S (RS).A 1.00 RS.

D S 4 100.

S S 5 100. T RSI.

Smoohing effec

F , UP DOWN

RSI.

T :

T UP , UP 13, ' UP

( ) 14.

S 3 6 RSI.

T RSI :

E . H, RSI

UP

DOWN .T , "H ?" RSI 0

100. T,

.

T . A RSI,

' .

J one ool

T R S I, ,


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cha eade. No ingle ool, mehod, o em i going o podce he igh ane 100 of he ime. Hoee, he RSI

can be a alable inp ino hi deciion-making poce.

Commodi Pice Cha plo he 14-da RSI, pdaing he cha hogh Thda of each eek. Cona o popla

opinion, he choice of he nmbe of make da ed in calclaing he RSI doen' eall mae becae he moohing

nae of he eponenial aeage edce he effec of he eal da a moe daa i inclded.

To help o pdae he RSI ale nil he ne ie of he cha aie, e li he "p aeage" and "don aeage" a

of Thda on each RSI cha.

Simplified formla

The pocede olined ealie fo beginning and pdaing RSI i fom J. Welle Wilde' book and hi 1978 Fe

Magaine o, hich made he RSI a popla echnical ool. The folloing i a imple and fae mehod of comping

he RSI. The el ae he ame a Wilde' moe complicaed mehod.

To begin a ne RSI, j li he change fo 14 conecie ading da and oal he change. Diide hee oal b 14,

and o ill hae he ne p and don aeage. Then poceed ih hi fomla:

RSI = 100 U / (U + D)U = p aeage; D = don aeage.

The eample belo i fo T-bill.

Date Up Don

1/28 +41

1/29 -2

2/1 -60

2/2 -7

2/3 +2

2/4 +1

2/5 +6

2/8 -26

2/9 +11


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2/10 +14

2/11 0 0

2/12 -11

2/16 +28

2/17 -18

Toal 103 124

1.03 / 14 = .074 = Up ae.

1.24 / 14 = .089 = Don ae.

RSI= 100 (.074 /.163) = 45.39

To calclae he ne da' RSI, mlipl he p aeage (.074) b 13. Add he change fo he da, if i i p. Diide he

oal b 14. Do he ame fo he ne don aeage. Mlipl he ne don aeage (.089) b 13. Add he change fo he

da, if i i don. Diide oal b 14.

Then, poceed ih he fomla:

RSI = 100 U / (U + D)

Fo eample, if T-Bill cloed p 25 poin he ne da, calclae he ne RSI a follo:

Ne Up ae. = .074(13) + .25/14 = .087Ne Don ae. = .089(13) + 0/14 = .083

Ne RSI = 100 .087 / (.087 + .083)

RSI = 51.2

Leaning o e hi inde i a lo like leaning o ead a cha. The moe o d he ineacion beeen cha moemen

and he Relaie Sengh Inde, he moe eealing he RSI ill become. If ed popel, he RSI can be a e alable

ool in inepeing cha moemen.

RSI poin ae ploed dail on a ba cha and, hen conneced, fom he RSI line. Hee ae ome hing he inde

indicae a hon b eample fom he folloing ile cha:


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Top and boom - Thee ae ofen indicaed hen he inde goe aboe 70 o belo 30. The inde ill all op o o

boom o befoe he acal make op o boom, giing an indicaion a eeal o a lea a ignifican eacion i

imminen.

The majo boom of Ag. 15 a accompanied b an RSI ale belo 30. The majo op of No. 9 a peceded b an

RSI ale aboe 70. The op made on Jan. 24 a peceded b an RSI ale of le han 70. Thi old indicae hi op

i le ignifican han he peio one and eihe a highe op i in he making o he long-em pend i nning o of

eam.

Cha fomaion - The inde ill dipla gaphic cha fomaion hich ma no be obio on a coeponding ba cha.

Fo inance, head-and-holde, op o boom, pennan o iangle ofen ho p on he inde o indicae beako


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and b and ell poin.

A decending iangle a fomed on he RSI cha ding Ocobe and eal Noembe ha i no eiden on he ba

cha. A beako of hi iangle indicae and inemediae moe in he diecion of he beako. Noe alo he long-em

coil on he RSI cha ih he lage nmbe of ppo poin.

Faile ing - Faile ing aboe 70 o belo 30 ae e ong indicaion of a make eeal.

Afe he RSI eceeded 70 ding Ocobe, he immediae doning caied o 65. When hi lo poin of 65 a

peneaed he folloing eek, he faile ing a compleed.

Afe he lo of Ag. 15, he RSI ho p o 41. Afe o doning, hi poin a peneaed on he pide on Ag.

26, compleing he faile ing.

Sppo and eiance - Aea of ppo and eiance ofen ho p cleal on he inde befoe becoming appaen on

he ba cha. Tendline on he ba cha ofen ho p a ppo line on he RSI. The mid-Noembe beak peneaed

he pend line on he ba cha a he ame ime a he ppo leel on he RSI cha.

Diegence - Diegence beeen pice acion and he RSI i a e ong indicao of a make ning poin and i he

ingle mo indicaie chaaceiic of he Relaie Sengh Inde. Diegence occ hen he RSI i inceaing and pice

moemen i eihe fla o deceaing. Coneel, diegence occ hen he RSI i deceaing and pice moemen i

eihe fla o inceaing. Diegence doe no occ a ee ning poin.

On he ile cha, hee a diegence beeen he ba cha and RSI a ee majo ning poin. The op made in

Noembe a "aned" b he RSI eceeding 70, a faile ing and diegence ih he RSI ning idea hile

pice conined o climb highe.

Aligh, i' ha ime again...

On hi cha fom he MakeClb membe' aea, a plo of he RSI i hon belo he main pice moemen cha. Can

o pick o he o poenial eeal on he RSI indicao?


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The answer is given here: Reveal the two reversals as indicated b the

RSI

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How to Use Relative Strength Index-RSI

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