RSI

 

RS=Average of x days up closes/Average of x days down closes

-The shorter the time period, the more sensitive the oscillator becomes and wider the amplitude.

-RSI works best when its fluctuations reach the upper and lower extremes.

-RSI lends itself well to trend line placement and is prone to experiencing divergence.

• A bullish divergence occurs when prices are declining but indicator values are increasing.
• A bearish divergence occurs when prices are increasing but indicator values are decreasing.
• Divergence carry greater significance when they appear at extreme RSI values.

-Stocks can spend extended periods of time in overbought and oversold regions and in reality this reflects on going strength and weakness.

• A 50% value of the RSI indicates that the average number of up-days is comparable to the average number of down days.
• A 70% value would actually reflect a 60% increase in the average number of up days compared to the number of the down days.
• A 30% index value would then reflect a 60% increase in the number of the down days compared to the number of the up-days for the same period.

-During an uptrend RSI will concentrate bulk of its action in the top half to two-thirds of the index value. As all healthy trends generally experience regular pauses in price action what is RSI going to do?Of course, its going to return back to the neutral region of 50% crossing the overbought region value of 70% .So every time a price action slows RSI gravitates back to the neutral region.

         I must understand that such retracement of RSI does not guarantee trend conclusion.Only act on RSI divergence if prices are still trending. Divergence occurring during the periods of consolidation are treated with caution.

-Examine RSI for extreme values when considering position entry.

 

 

 

Interpretation
When Wilder introduced the RSI, he recommended using a 14-day RSI. Since then, the 9-day and 25-day RSIs have also gained popularity. Because you can vary the number of time periods in the RSI calculation, I suggest that you experiment to find the period that works best for you. (The fewer days used to
calculate the RSI, the more volatile the indicator.)
The RSI is a price-following oscillator that ranges between 0 and 100.

A popular method of analysing the RSI is to look for a divergence in which the security is making a new high, but the RSI is failing to surpass its previous high. This divergence is an indication of an impending reversal. When the RSI then turns
down and falls below its most recent trough, it is said to have completed a "failure swing." The failure swing is considered a confirmation of the impending reversal.

In Mr. Wilder's book, he discusses five uses of the RSI in analysing commodity
charts. These methods can be applied to other security types as well.

• Tops and Bottoms.
  The RSI usually tops above 70 and bottoms below 30. It usually forms these tops and bottoms before the underlying price chart.
• Chart Formations.
  The RSI often forms chart patterns such as head and shoulders (page 215) or triangles (page 216) that may or may not be visible on the price chart.
• Failure Swings
  (also known as support or resistance penetrations or breakouts). This is where the RSI surpasses a previous high (peak) or falls below a recent low (trough).
• Support and Resistance.
  The RSI shows, sometimes more clearly than price themselves, levels of support and resistance.
• Divergences.
  As discussed above, divergences occur when the price makes a new high (or low) that is not confirmed by a new high (or low) in the RSI. Prices usually correct and move in the direction of the RSI.

Overbought/Oversold

Wilder recommended using 70 and 30 and overbought and oversold levels respectively. Generally, if the RSI rises above 30 it is considered bullish for the underlying stock. Conversely, if the RSI falls below 70, it is a bearish signal. Some traders identify the long-term trend and then use extreme readings for entry points. If the long-term trend is bullish, then oversold readings could mark potential entry points.

Divergences

Buy and sell signals can also be generated by looking for positive and negative divergences between the RSI and the underlying stock. For example, consider a falling stock whose RSI rises from a low point of (for example) 15 back up to say, 55. Because of how the RSI is constructed, the underlying stock will often reverse its direction soon after such a divergence. As in that example, divergences that occur after an overbought or oversold reading usually provide more reliable signals.

Centreline Crossover

The centreline for RSI is 50. Readings above and below can give the indicator a bullish or bearish tilt. On the whole, a reading above 50 indicates that average gains are higher than average losses and a reading below 50 indicates that losses are winning the battle. Some traders look for a move above 50 to confirm bullish signals or a move below 50 to confirm bearish signals.