The Relative Strength Index or RSI is an oscillator widely used by those who trade futures, including through CFDs. This indicator solves some problems in the construction of the Momentum line and offers several useful indications.
Before continuing with the lesson, it is good to note that to apply the RSI oscillator you simply need a trading platform. With the eToro platform you can apply with one click, from the specific page of the chart. Login to the platform here and practice with a demo account with no deposit required.
RSI oscillator, characteristics
This index, according to its creator John Welles Wilder, was created to solve two problems in the construction of the Momentum.
The first problem is the erratic movements of the Momentum , caused by sudden variations, which the data series can miss. In fact, if there was a sharp rise or fall in the previous 10 days, the momentum line could suddenly reverse, even though current prices have minor variations. For this reason, it is necessary to make some presentations to minimize such distortions.
The second problem is that of needing constant bands to be able to make comparisons . In addition to smoothing (solving the first problem), the RSI oscillator also creates a constant vertical range between 0 and 100.
Here is the formula used to calculate the RSI:
RSI = 100 – [100 / (1 + RS)]
where RS = (average increase in closings of x days) / (average decrease in closings of x days)
Here we have written the days, but the weekly periods can also be taken into account. For example, 14 days or 14 weeks instead of x.
Remember that to get the chart with the RSI you do not need to calculate anything by hand, since the trading platform does everything automatically.
The Relative Strength Index indicator indicates situations of:
- Overbought: when it exceeds level 70;
- Overbought of a bull market: when it rises above 80;
- Oversold: when it falls below level 30;
- Oversold of a bear market: when it falls below 20.
In addition, we have these situations:
- Failure balance: when in an uptrend the maximum of the RSI does not exceed the previous high and is followed by a break of the previous low;
- Bottom Failure Oscillation: When in a downtrend, the RSI low fails to break the previous low and is followed by a break from the previous high.
As you may well guess, the RSI index allows you to predict potential trend reversals.
Don’t confuse RSI with relative strength
When we talk about RSI we are talking about the oscillator type indicator and we have nothing to do with the «Relative strength», which is a line graph that relates two different entities (for example, a stock with an index).