Relative Strength Index (RSI) is a commonly used technical analysis indicator designed to measure the speed and change of stock price movements. RSI is typically used to determine whether the market is in an overbought or oversold state, thus predicting potential reversal points in stock prices.
The Meaning of RSI
RSI is an indicator developed by technical analyst J. Welles Wilder Jr. in 1978. It measures market buying and selling pressure by comparing the average gains and losses over a specific period. RSI values range from 0 to 100, and it is generally set for a 14-day trading period.
Calculation of RSI
The formula for calculating the Relative Strength Index (RSI) is as follows:
Assuming we use a 14-day period to calculate RSI:
Calculate Gains and Losses:
Average Gain: The average gain of all up days over a 14-day period.
Average Loss: The average loss of all down days over a 14-day period.
Calculate RS (Relative Strength):
計算 RSI：
This formula converts RS into a value between 0 and 100, which indicates whether the market is overbought or oversold.
RS (Relative Strength) is the ratio of the Average Gain to the Average Loss.
How to Use RSI to Determine Stock Price Movements
Identify Overbought and Oversold Conditions:
Overbought Area (RSI > 70): When RSI is above 70, the stock is considered overbought, suggesting that buying pressure may have been too strong, and the stock price might correct. Therefore, investors might consider selling or holding cash.
Oversold Area (RSI < 30): When RSI is below 30, the stock is considered oversold, suggesting that selling pressure may have been too strong, and the stock price might rebound. Therefore, investors might consider buying or increasing their positions.
RSI Divergence:
Bullish Divergence: When the stock price makes a new low, but RSI does not make a new low, it indicates weakening downside momentum, which is a potential buy signal.
Bearish Divergence: When the stock price makes a new high, but RSI does not make a new high, it indicates weakening upside momentum, which is a potential sell signal.
RSI Midline (50):
The midline of RSI at 50 is often used to determine the market trend direction:
When RSI is above 50, the market trend is likely upward.
When RSI is below 50, the market trend is likely downward.
RSI Crossover Strategy:
When RSI crosses above the 30 line from below, it may be a buy signal.
When RSI crosses below the 70 line from above, it may be a sell signal.
Example of Applying RSI
Suppose a stock has an RSI of 75, indicating that the stock is in an overbought condition. Investors might think the stock price has been pushed too high and prepare to sell for profit. Additionally, if RSI starts to decline from 75 and falls below 70, this would reinforce the decision to sell.
Conversely, if a stock has an RSI of 25, indicating that it is in an oversold condition, investors might think the stock price has been pushed too low and consider buying. If RSI starts to rise from 25 and crosses above 30, this would reinforce the decision to buy.
Precautions
False Signals:
RSI may remain in overbought or oversold areas for extended periods in a strongly trending market (either upward or downward), so relying solely on RSI for trading decisions might produce false signals.
Combining with Other Indicators: Investors should combine RSI with other technical indicators (such as moving averages, MACD, volume, etc.) to increase the accuracy of their analysis.
Adjusting the Period: The default period for RSI is 14 days, but investors can adjust the period according to their trading style. For example, short-term traders might choose a shorter period (like 9 days), while long-term investors might choose a longer period (like 21 days).
By understanding the principles and applications of RSI, investors can better identify overbought and oversold conditions in the market, leading to more informed investment decisions.