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The Relative Strength

Here, one of the most popular indicators found in most analytical software packages is explained.

When the relative strength index (RSI) became popular in the 1980s, it was touted as the indicator that led every turn in the market. Indeed, for certain futures contracts, financials and currencies, it could be prescient: In those markets, it had the peculiar ability to turn just as the financials would find a level of support or resistance beforeВ  taking off to another price level.

On other items, say, pork bellies or corn or cocoa, it would ape the price swings precisely. However, on trending prices, it would go up the limits of its excursion and bounce around there for weeks or months until the trend finally reversed. For stocks, its performance could be all over, depending on the trading characteristics of the stock in question. Clearly, this was an indicator with promise but tricky implementation.

ONE OF A CLASS

J. Welles Wilder’s relative strength index is one of a class of indicators known as oscillators. These indicators bounce around (or oscillate) between fixed extreme values based on price movement or position of close in range or change in price over time. In the case of RSI, the values can range from zero to 100 but typically fall between 20 and 80.

Like many mainstays, the RSI was introduced in Wilder’s New Concepts in Technical Trading Systems. There, Wilder outlined its strengths, including three that I think make it the best overall indicator:

1 Excursions beyond 70 and 30 are setups for tops andВ  bottoms.

2 Chart formations that aren’t apparent on the price chart are clear in RSI’s line format.

3 Divergence between RSI and price is a clear warning of imminent reversal.

For the record, Wilder also felt that support and resistance were more apparent on the RSI line than in price charts and that RSI’s failure swings were strong signals of price reversals. I think these two characteristics are included in those above, as we’ll see later.

In addition, one characteristic of RSI that Wilder didn’t mention is its simple direction: If it’s going up, so are prices.

If it’s going down, look south. Therefore, heeding the direction of the RSI should alert you to the trend, depending on the lookback period that you’ve chosen.