Relative Strength Index (RSI) RSI was featured in J. Welles Wilders book New Concepts in Technical Trading Systems and its still widely used almost 40 years later. The RSI is, just like the MACD or Stochastic, a momentum oscillator and requires additional confirmation before going long or short. What is the RSI? The Relative Strength Index (RSI) represents the size of recent gains and losses during a specified time period, and measures the speed of these price movements. Its primarily used to identify potential overbought and oversold situations for a currency pair.

Wilder recommends using a 14-day period as the standard setting for the RSI. The RSI has a higher value when the average gains for the specified period are larger than the average losses. On the other hand, when average losses are larger than average gains during the period, the RSI value moves down. The following chart shows the RSI indicator on the EUR/USD currency pair (blue), notice how the value of the RSI is normalized between 0 and 100. The RSI can also be used on other time frames than the daily, but its important to remember that a shorter time period creates a more volatile RSI, while a longer period creates an RSI less sensitive to price changes. The indicator is calculated the following way: RSI = 100 [100/(1+RS)] RS = Smoothed Average Gain / Smoothed Average Loss Average Gain = Sum of gains for the specified period Average Loss = Sum of losses over the specified period To create a Smoothed Average Gain, the following calculation is performed:

Smoothed Average Gain = [(previous Average Gain) x 13 + current Gain] Smoothed Average Loss = [(previous Average Loss) x 13 + current Loss] Wilder normalized the RSI with this formula to have a range value from 0 to 100. If over the specified period, each session was a gain, then the RSI would have a value of 100. If each session were a loss, the RSI would have a value of 0. How to use RSI The RSI is a multi - purpose indicator, and the most popular uses of RSI are included below. Identifying overbought/oversold areas. Trading the RSI divergence.

Overbought and oversold areas RSI is widely used to identify when a currency pair (or another financial instrument) is overbought or oversold. The typical values used for this are 30, which indicates an oversold area, and 70, which indicates an overbought area. If the price moved upwards strong in the recent periods, the RSI will react with a higher value. The presumption behind this is that a quick jump in price is usually not sustainable and will eventually result in a correction downward. Therefore, if the value of the RSI is 70 or more, its considered an overbought area and traders should expect a drop in the price. Similarly, a quick drop in the price will move the value of the RSI lower into the area of oversold conditions. In this case, if the RSI shows 30 or lower, traders should be prepared for a possible correction move to the upside.