What is RSI Relative Strength Index ?
Relative Strength Index (RSI), developed by J. Welles Wilder is a momentum oscillator used to analyze charts. It is used to measure market strength and weakness indicating overbought and oversold conditions based on the period’s closing prices. It is also used to determine entry and exit points. Signals generated by the Relative Strength Index are divergences, failure swings and centre crossovers.
There is a difference between Relative Strength and Relative Strength Index. Relative Strength measures two different entities by means of a ratio line and Relative Strength Index measures the velocity and magnitude of directional price movements. Momentum is the rising and falling rates in price. Prices with more or stronger positive changes have a higher RSI than prices with more or stronger negative changes in prices. Relative Strength Index is measured on a scale from the minimum of zero to the maximum of 100 and with levels at marked at 70 and 30 or 80 and 20.
When Relative Strength Index reaches the scale above 80 is considered overbought and below 20 is considered oversold. The slope of the Relative Strength Index is directly proportional to the velocity of a change in trend. The distance traveled by the Relative Strength Index is proportional to the magnitude of the price movements.
FAILURE SWING
Failure swing indicates market reversal confirming buying and selling points.
When Relative Strength Index climbs above the overbought zone, 80 and above, drops to form a failure point and rises again but fall short of the previous high, and falls again. When Relative Strength Index drops below the failure point triggers a selling signal.
When Relative Strength Index drops below the oversold zone, 20 and below, rises to form a failure point and decline again but fall short of the previous low, and rise again. When Relative Strength Index rises above the failure point triggers a buying signal.
DIVERGENCE
Divergence between Relative Strength Index and prices is a strong indication that market is turning. Bullish divergence occurs when prices establish new low but Relative Strength Index makes higher low. Bearish divergence occurs when prices establish new high but Relative Strength Index makes a lower high.