Relative Strength Index

Relative Strength Index Calculation (RSI)

What is the rsi calculation and its formula? The relative strength index is a momentum indicator that shows overbought and oversold levels when trading. When stocks become overextended, they are like rubber bands that naturally want to pull back to equilibrium levels. Pay attention when a stock becomes overextended because a pullback or extreme move in the stock may be upcoming.

Technical analysis is an important part of successful trading. Knowing how to use the RSI calculation helps keep trades in perspective.

Day traders are hunters of volatility, and the relative strength index shows momentum. The stock market is a tug-of-war between the bulls and the bears. As a result, technical indicators can be used to quiet the noise.

  1. RSI calculation, aka relative strength index, is an oscillating indicator that is displayed as a line
  2. It moves between two extremes: overbought and oversold
  3. The bullish and bearish price movements are plotted against a stock’s price
  4. Compares bullish and bearish price movements and maps them out as an oscillator
  5.  The calculated range of the RSI is 0-100
  6. Oversold levels are between 0 and 30. Overbought areas are between 70-100
  7. Average gain or loss is the average % gains or losses over a look-back period of 14 days
  8. Uses positive values for the average loss
  9. The 14-day period to calculate the second half of the RSI calculation
  10. RSI rises as # of positive closes increases & falls as # of negative closes increases as well

Momentum Indicator

The RSI, also known as the relative strength index, is a momentum indicator. Investopedia measures the magnitude of recent price changes to evaluate overbought or oversold conditions in the price of a stock or other asset.

The RSI calculation was developed in 1978 by J. Welles Wilder. It was first introduced in his book New Concepts in Technical Trading Systems. The relative strength index gives you clues as to the strength of a trend or if a pullback or reversal is about to occur. Usually, you want to crosscheck the RSI against other technical indicators.

That will tell you whether or not the current trend is strong or a pullback is imminent. Conformation is key in trading.

RSI Calculation Math

The RSI calculation is a two-part calculation. The Bullish Bears is a trading service that researches what an indicator does and its psychology.

Hence, we are delving into the math that makes up the RSI calculation. If you’re a technical person, sometimes knowing how things work can make you better understand what’s happening.

Let’s take a look at step one of the RSI calculation:

RSI Calculation Math

The average gain or loss is the average percentage of gains or losses over a look-back period of 14 days. This uses positive values for the average loss.

You need 14 days to calculate the second half of the RSI calculation. The second step is what smooths out the noise. The second RSI calculation looks like this:

 
RSI Calculation Example

Those calculations show us the movement of the market or the stock you’re looking at. The first RSI calculation shows the number and size of price increases or decreases.

The RSI rises as the number of positive closes increases. The opposite is also true. RSI falls as the number of negative closes increases as well.

Then, the second RSI calculation is done to smooth out the price movement. Hence, you see the RSI indicator on your charts. It only becomes overbought or oversold in trending markets.

What Does RSI Calculation Tell You?

When we think of the RSI calculation, we typically consider it regarding potential pullbacks or reversals. However, it can also be used to confirm a current strong trend.

If you watch our watch list videos, you’ll notice how closely we pay attention to RSI when looking at potential plays. That’s because we want to determine whether a stock is ready for a pullback or the current trend is strong.

Typically, when you see the RSI in the 70-100 percentile, you expect the stock to come down in price. When the stock is in the 0-30 percentile, you know the price will reverse, usually to the bullish side.

However, it doesn’t always happen right away. This is because sometimes a trend is strong, and the relative strength index confirms it.

COURSE
Day Trading Course Options Trading Course Futures Trading Course
DESCRIPTION Learn how to read penny stock charts, premarket preparation, target buy and sell zones, scan for stocks to trade, and get ready for live day trading action
Learn how to buy and sell options, assignment options, implement vertical spreads, and the most popular strategies, and prepare for live options trading How to read futures charts, margin requirements, learn the COT report, indicators, and the most popular trading strategies, and prepare for live futures trading
INCLUDED

Avoiding a Trap

One thing you want to avoid is relying heavily on just one indicator. That can result in getting trapped or faked out. Hence, there is a need to learn stock trading.

The need to look at more than one indicator for confirmation is key. Many technical indicators are lagging indicators. As a result, they can be a little behind on moves.

You can better understand what’s going on when you compare the relative strength index to the MACD, VWAP, and moving averages.

Moving average lines act as equilibrium to stocks. Therefore, look for a potential pullback if a stock has an overbought or oversold RSI and the price is far from moving averages.

However, if the price is riding the moving average lines and the relative strength index is still overbought or oversold, you could be looking at trend confirmation.

What the Patterns Tell You

Not only should you use technical analysis to trade, but candlesticks and patterns are just as important, if not more so. Candlesticks are the foundation of trading. Take our day trading course.

They are formed from the tug of war between buyers and sellers and help calculate the RSI. As a result, you can see the emotions of traders along with support and resistance.

Support and resistance play a huge role in trading. As a result, you can determine the relative strength index calculation regarding where support and resistance map out.

Technical analysis, candlesticks, and patterns all work hand in hand to give you a clear picture of potential moves. However, nothing is 100% certain. Take our online trading courses to learn more about implementing these trading tools into your strategy.

Final Thoughts: RSI Calculation

The RSI calculation is a technical indicator that maps out overbought and oversold areas. This can result in a pullback, reversal, or trend confirmation. This indicator works best within a strong trend.

As a result, compare what the relative strength index is telling you to other indicators and candlestick patterns. No indicator is perfect and should be relied on by itself.

Frequently Asked Questions

  1. The best rsi setting differs based on trading strategy
  2. The default setting is 14 periods and is most commonly used
  3. Some traders like to use the 10 period for shorter overbought/oversold levels

  1. You should look to buy when RSI is in the oversold area anywhere below 30
  2. When RSI is between 70-100 that is a potential sell signal
  3. Relative strength index isn't a buy or sell signal, it's used more as a guide
  4. Candlesticks are much better buy and sell signals than RSI

Related Articles

Harmonic Patterns

Harmonic Patterns

Have you heard of Harmonic patterns? Technical analysis can be a polarizing subject in the world of investing. Some traders swear by it, while others

Read More »

FREE ONLINE TRADING COURSES

If you’ve looked for trading education elsewhere then you’ll notice that it can be very costly.

We are opposed to charging ridiculous amounts to access experience and quality information. 

That being said, our website is a great resource for traders or investors of all levels to learn about day trading stocks, futures, and options. Swing trading too! 

On our site, you will find thousands of dollars worth of free online trading courses, tutorials, and reviews.

We put all of the tools available to traders to the test and give you first-hand experience in stock trading you won’t find elsewhere.

Our content is packed with the essential knowledge that’s needed to help you to become a successful trader.

It’s important to treat day trading stocks, options, futures, and swing trading like you would with getting a professional degree, a new trade, or starting any new career.

Invest the proper time into your Trading Education and don’t try to run before you learn to crawl. Trading stocks is not a get-rich-quick scheme. It’s not gambling either, though there are people who treat it this way. Don’t be that person! 

STOCK TRADING COURSES FOR BEGINNERS

The Bullish Bears team focuses on keeping things as simple as possible in our online trading courses and chat rooms. We provide our members with courses of all different trading levels and topics.

If you’re a beginner, intermediate level, or looking for expert trading knowledge…we’ve got you covered. 

We have a basic stock trading course, swing trading course, 2 day trading courses, 2 options courses, 2 candlesticks courses, and broker courses to help you get started. Free.

Just choose the course level that you’re most interested in and get started on the right path now. Become a leader, not a follower. When you’re ready you can join our chat rooms and access our Next Level training library. No rush. We’re here to help.

Click Here to take our free courses.