- Calculation formula Relative Strength Index.
- Description and principle of operation of the indicator.
- Settings and Signal Levels (overbought / oversold).
- RSI Application Examples.
- Divergence and Convergence RSI.
- Disadvantages of the RSI indicator.
For the first time, the RSI indicator (Relative Strength Index) appeared in 1978. Since then, it has gained immense popularity and has become a favorite tool of traders.
The Relative Strength Index can be calculated by the formula:
where RS is the quotient of the average value of price growth and the average value of price reduction for the period n (14 by default). It is important to understand that when calculating the length of a rising or falling candle, by default only closing prices are taken into account, not their shadow.
RSI (Relative Strength Index) is inherently an oscillatory indicator that ranges from 0 to 100. As can be understood from formula, 0 it is achieved in the absence of growing (bullish) candles for the specified period. The value of 100 is reached in the absence of falling (bearish) candles for the specified indicator period. Thus, it displays overbought or oversold assets. The indicator shows in which direction the market moved more often over a selected period of time, based on the length of the candles. The following conclusions can be drawn from this:
– the stronger the relative upward movement of the price (the greater the total length of growing candles), the closer the indicator value to 100;
– the stronger the relative movement of the price down (the greater the total length of the falling ones), the closer the indicator value to 0.
The RSI indicator has only one input parameter, which you can configure for yourself and use different values – this is the period. According to the author, the default value is 14, which was used to analyze the daily candles. For smaller timeframes, you should choose a different input parameter.
As already mentioned, the RSI indicator line ranges from 0 to 100. But they are very rarely achieved, therefore, in practice, they use signal levels 30 and 70. It is generally accepted that the value of the indicator is above 70, indicating an overbought asset. Therefore, it is not worth opening long positions, but it’s better to fix completely or part of the position or tighten the stop loss, waiting for correction. An indicator value below 30 indicates oversold, consider buying an asset or pulling up a stop loss for existing short positions.
However, on pronounced trends, to reduce the number of false signals, it is desirable to use the values of other levels, shifting the base values to “+” or “-” 10. For an uptrend, it is recommended to use levels 40 and 80. Above 80, we fix a position or tighten a stop loss, and with a value below 40 you can consider buying.
For a downtrend, levels of 20 and 60 will be more suitable. It is worth considering sales above level 60, and at 20 we tighten stop loss or fix a deal.
The RSI indicator when crossing line 50 gives the support / resistance area.
The figure shows how the price fluctuates around this level. After breaking through the price level and fixing the indicator line above or below 50, you can determine a new direction of movement of the asset.
Another way to determine the direction of the trend is using levels 20 and 80 of the RSI indicator. After the first touch of level 20, a downtrend is considered until it crosses level 80. And with an uptrend, on the contrary, the indicator breaks the value of 80 and in the future does not fall to 20.
Divergence is a situation in which the values of the indicator and prices diverge. Divergence is a bearish formation in which price highs are updated, but at the same time the extremes of the RSI indicator values decrease.
Convergence is a situation in which the values of the indicator and price converge. Convergence refers to a bullish formation in which price lows are updated, but local lows of the RSI indicator increase.
Divergence and convergence is one of the strongest signals of technical analysis, indicating the imminent change in market direction.
Based on the RSI formula, it is a lagging indicator. Initially, it was designed for a daily timeframe, so at lower it will give a large number of false signals.
For a more reliable market entry point, the RSI indicator should compare the values of different timeframes. While a bearish signal may appear on the hourly timeframe of the chart, oversold may appear on the 4-hour chart. Therefore, it is advisable to choose an entry point when the indicator on two timeframes sends a signal in the same direction.
The RSI indicator is a classic trading. Therefore, many trading systems are built with his help. This indicator is best used as a filter for market entry points. In conclusion, I recommend reading about the ATP indicator in order to set the correct stop loss.