Introduction to RSI indicator
The RSI indicator (Relative Strength Index) was pioneered by Wells Wilde in his book "New Ideas in Technical Trading Systems" (published in 1978). We only present the essentials of this approach here. If friends want to know more about it, please read Wilde's original work.
The formula of the RSI (x) indicator is (just look at it, don’t memorize it):
RSI = 100 - [100/（1+RS）]，
RS=average of rising closing prices in x days/average of falling closing prices in x days
Wilde originally used a time span of 14 days. Some technical analysis charts use a 6-day time interval. The shorter the time span, the more sensitive the Oscillator Index and the greater its range of changes. It works best when the RSI hits the upper or lower limits. Therefore, if a user is trading on a shorter time base, requiring swings to be more pronounced, one might wish to shorten their time span. If the time span is enlarged, the swing index becomes smoother and the range is narrower, so the range of the 14-day swing index is larger than the original 6-day swing index range.
Usage of RSI
We plot the RSI on a chart with a vertical scale from 0 to 100. When it reads over 80, it is overbought, and when it reads below 20, it is oversold (since it has a larger swing on the 6-day RSI chart, we use 80 respectively and 20 to replace the two limits of 70 and 30). However, the RSI can drift during bull and bear markets, so 90 is usually an overbought level in a bull market, and 10 is an oversold level in a bear market.
RSI divergence occurs when the RSI is above 70 or below 30. The so-called top divergence means that in an upward trend, the new peak of RSI (above 70) cannot exceed the previous peak, and then falls below the previous trough. At this time, the market is bearish.
The so-called RSI bottom divergence means that in a downtrend, the new round of RSI valley (below 30) is unable to fall past the previous valley, and then breaks through the previous peak. At this time, the market is bullish.
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