RSI readings are displayed with a scale of 0, to 100; in which case 70 indicates the ‘overbought’ zone, while 30 or less indicates an ‘oversold’ zone.
What separates the amateurs from the traders, is that the pro’s make use of a variety of strategies, in order to maximize profits, and minimize losses. One such strategy is known as the relative strength index, or, RSI when abbreviated.
One of the most important and ever appearing indicators in the market, the RSI, is calculated on the basis of the velocity and direction of a commodities’ price fluctuation. The RSI indicator is responsible for measuring the commodities’ full potential, however, it is essential to know that the RSI is only an oscillator which (as well as) measuring the internal strength of a commodity, but also gives in-depth data about trends, which is based on past fluctuations.
The RSI is used by professional traders, globally, for both the short term and the long-term strategies. Apart from the indication of over-bought/sold levels, the RSI also aid in making decisions, and may allow traders to efficiently determine entry, as well as exit points – based on the financial markets’ state.
In simple terms, these signals indicate to buy or sell, and give an overview of general price fluctuations, reversals and trends. On the basis of the data provided by implementing RSI, traders may make informed trading decisions.
Please keep in Mind When Using the RSI Indicator:
The most common mistake which traders make, is that the price action/fluctuation of a particular commodity and only rely on the indicator itself. It is necessary to understand that these indicators are not a direct representation of the price action. Despite being buy, and sell signals, the RSI could be used in parallel with trend lines, and other technical analysis tools, in order to prevent false buy, and sell signals. This is mainly due to the fact that at times, a sudden spike, or surge, in price fluctuations may generate false buy/sell signals, therefore making traders conduct hasty decisions, which may end up being destructive.
The RSI is calculated on the basis of the formulae given below:
RS = Average Gain /Average Loss
The basic components of the RSI are RS and Average Gain and Average Loss. As explained by Wilder in his book, RS computing is mapped on a 14-day cycle that is set as a default. Here, losses are not considered as negative values but as positive.
Calculation 1 – Average gain and average loss on the default 14-day cycle:
Calculation 2 and thereafter – Based on the previous averages and the current gain/loss:
Using prior value plus current value is a simplifying system, similar to that used in exponential moving average calculations. The RSI values become more accurate as the calculation period extends. Sharp Charts uses at least 250 data points before the commencing date of any chart (assuming that much data exists) when calculating its RSI values. To exactly replicate RSI numbers, a formula will require at least 250 data points.
The price level at which demand is considered to be in the favorable position to restrain the price from decreasing is called support. The price level which selling is considered to be the favorable position, and to sway the price from increasing further is called the resistance.
In present times, there are multiple indicators which are being created every week; but the RSI indicator remains to be dubbed as one of the most reliable and beneficial ones; this is because they provide traders with detailed analysis which is related to the general price movements, reversals and trend lines, as well as overviews of the supply and demand of the market/instrument/etc. in question.
Before experimenting with such indicators, it is advised to become well acknowledged with the technical and intricate side of these things, in order to prevent any mistakes or uncalculated decisions.