Technical Indicators: Relative Strength Index
And, today, we dive back into lower indicators or charts which are not graphed directly on the price chart. We’ve already discussed a few of these, MACD and Volume/Volume+, but now we’ll go through all the available ones on bigcharts.com. The one pictured as the third chart in the picture above is the Relative Strength Index (RSI).
The RSI chart is considered an oscillator since it is designed to oscillate between values 0 to 100 and different types of movement within the chart can be used as indicators for buying, selling, or trending. The RSI on bigcharts.com is set to a 14-day period and is governed by the equation RSI = 100 – (100/(1 + Relative Strength)). Relative Strength is the average of the last 14 price up closes divided by the average of the last 14 price down closes. A more robust charting program that allows you to change the period of relative strength would obviously just be a change in how many price up or price down days are averaged for the Relative Strength.
The name RSI is a little bit mis-leading in that it does not give you a comparison of strength of the stock versus other stocks. Instead, as you can see from the equation, RSI gives you an idea of how strong price up or price down movements are relative to the stock’s previous price movements.
So, the all important question remains, how do you use it? Since the RSI is based off of price closes, it is in some ways redundant to a lot of moving average based indicators so I would suggest it as a replacement for MACD and other such indicators as opposed to a confirmation of trends that you might spot. I sometimes will use RSI and MACD together when one is unclear, but I do not use the two exclusively in any decision making.
While I did say that MACD and RSI will give you similar information, it is in that they are derived from the same data. I typically use RSI in a little different fashion than I use MACD, however. MACD, in my experience, is typically a good indicator to use for signaling while RSI is, what I like to call, a confirmation indicator. For example, a breakout should be confirmed with an RSI spike that is not just a spike in the near term but high relative to the rest of the RSI curve. A stock reaching its 52-week highs should also have corresponding 52-week highs in their RSI. Also, RSI can be used to tell you if a stock is overbought or oversold. For most analysts, RSI above 70 is considered overbought territory and the stock price is likely to have more down days in the future and RSI below 30 is oversold and the stock price is likely to have some more up days in the future. That being said, crossing over and then crossing back at 70 or 30 is never necessarily a clear sell or buy signal but one that can be used to confirm buying and selling signals. Real trends on the RSI curve are not usually established until you see a consistent push passed the 50 line, but, by then, you will likely have made a move on the stock due to other indicators.
Take a look at the above graph. I have plotted Price Channel and Volume+ and given knowledge from previous posts on those indicators see if you can see confirmations for buy and sell signals in the RSI curve. See if RSI can be used to preempt either of those curves. This is a good experiment and I do recommend you do it for several stocks as practice for developing intuition in reading technical indicators.
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