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Relative Strength Index

ForexZig.com January 19, 2013

Relative Strength Index (RSI) is a technical indicator that is used for making analysis on the financial market. This is a momentum oscillator that modifies the speed and change of price movements. It was developed and designed by J. Welles Wilder. Later in 1978 he introduced the Relative Strength Index in his book New Concepts in Technical Trading Systems. In addition this book consists of the Parabolic SAR, Average True Range and the Directional Movement Concept (ADX). In spite of the fact that this indicator was developed before the computer age, it has successfully stood the test of time and it stayed rather popular.

This price-following oscillator ranges between 0 and 100. When Wilder initiated the Relative Strength Index, he advised market participants to use a 14-day RSI. However from then, the9-dayand25-dayRelative Strength Index indicators became widely used as well.

The most common method to work with the RSI is to search for a divergence where the security is making a new high, but the RSI cannot exceed its previous high. This divergence represents an indication of an impending reversal. Then, it the Relative Strength Index turns down and moves below its most recent bottom, it is supposed to have completed the so-called failure swing. The failure swing is actually a confirmation of the further reversal.

RSI

Relative Strength Index; USDJPY / H1

How to make analysis with the Relative Strength Index indicator ->

  • Tops and bottoms
    The Relative Strength Index often tops over 70 and bottoms under30. It generally forms these highs and lows before the underlying price chart;
  • Chart Formations
    The RSI usually makes chart patterns resembling head and shoulders or triangles that are or are not visible on the price chart;
  • Failure swing
    This is where the Relative Strength Index exceeds a previous peak or falls under a recent bottom;
  • Support and Resistance levels
    From time to time, the Relative Strength Index indicates more clearly than price themselves, level of support and level of resistance.
  • Divergences
    As it is already mentioned above, divergences appear when the price makes a new top (or bottom) that is not confirmed by a new top (or bottom) in the Relative Strength Index. Prices often correct and move in the direction of the RSI.

Calculation of this technical indicator:

RSI = 100-(100/(1+U/D))

Where -> U — is the average number of positive price changes and D — is the average number of negative price changes.

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