Oscillator Indicator: Relative Strength Index (RSI)
Relative Strength Index (RSI or Relative Strength Index) is a very useful indicator of momentum oscillation developed by J. Welles Wilder and is one of the most widely used indicators of technical analysis. RSI was first introduced in J. Welles Wilder’s book, New Concepts in Technical Trading Systems in 1978. This indicator compares the magnitude of recent pair gains with recent losses to determine overbought and oversold conditions selling).
The RSI indicator is calculated in two stages. First Relative Strength (RS) is determined by dividing the average gain (rising candle) over the past period by the average loss (candle down) over the past period. However, this is not the actual average because it is shared by the past period. The following formula is used to determine the RS:
RS = ((The amount of profit in the price + the profit of this candle) / n) / ((The amount of loss in the price + this candle loss) / n)
n is the past period;
the amount of profit in the price is calculated over the period n – 1 (one period less than the previous period);
the amount of loss in the price is also calculated during the period n – 1.
The second step keeps the RS into the range 0 to 100 and generates RSI. The formula for the second step is:
RSI = 100 – 100 / (1 – RS)
The default period, as Wilder recommends, is 14 although some traders prefer to use RSI period 8 on intraday timeframes, while others prefer to use the 28-period RSI.
In the classical view, the pair is considered overbought when the RSI reading is above 70 and oversold when the RSI reading falls below 30. This makes it a good indicator for the average reversal system. Wilder recommends the use of 70 and 30 levels as overbought and oversold levels respectively. As the RSI moves up above the 30 line, this is considered a possible bullish reversal when a move down below the 70 line is considered a possible bearish reversal.