Description and application of the RSI indicator (Relative Strength Index)

RSI indicator (Relative Strength Index), description and application of the relative strength indicator in practice in trading.

What is the RSI indicator and what is the meaning, the formula for calculating the Relative Strength Index

Decisions made by a trader on the stock exchange are always associated with a certain risk. In order to reduce it as much as possible, it is necessary to think over, formulate and apply a certain trading system. One of its important points is the ability to choose the right entry point for a trade. This can be done using the Relative Strength Index indicator. It was invented by trader Wells Wilder. He published an article about it in 1978. She appeared in Commodities magazine. It is interesting to note that Wells Wilder was an engineer by training. This indicator was discussed in more detail in his book New Concepts in Trading Systems. Over time, the Relative Strength Index has become very popular. Now it is included in the standard set of indicators of almost every
trading terminal.

The RSI indicator is designed to identify overbought and oversold zones. On the terminal, it is located in a separate window. RSI values ​​can range from 0 to 100. Levels 30 and 70 are of particular importance. If the price is less than the first or greater than the second, then we are talking about oversold or overbought, respectively. Sometimes 20 and 80 are used instead of the indicated levels.
In the first case, it is important that the probability of a subsequent upward movement of the price increases, and this allows us to consider the situation as favorable for buying an asset. Similarly, when overbought, you can expect a further fall in price, which favors the implementation of the sale transaction.

The indicator helps to establish the characteristics of price impulses without delay. An important advantage of RSI is that it is effective in almost all types of exchange markets.

The indicator calculation algorithm is as follows:

1. At the very beginning, choose the type of price that you plan to use for calculations. For example, Close (the closing price) will be used.
2. Let’s denote the number of the current bar as 0. We need to fix the difference between the Close prices of bars 0 and 1. This operation is performed a number of times equal to N, the dimension specified when entering the parameters.
3. The results obtained should be divided into two groups. One of them (A) will have positive values, the other (B) will have zero and negative values.
4. In each of the groups obtained, we must take the exponential average of these numbers. In this case, averaging occurs not by the number of elements of this group, but by N. In this case, two numbers will be obtained: the average of positive values ​​(PS) and of negative ones (OS).
5. Next, you need to get the quotient (H) from dividing the PS by the OS, taken with the Plus sign.
6. To get the indicator value, you need to use the following formula: RSI = 100 – 100 / (1 + H).

This method of calculation was proposed by the creator of this indicator — Wells Wilder. The following types of prices can be used for calculation:

• opening price;
• closing price;
• maximum;
• minimum;
• median price, which is the arithmetic mean of the sum of the maximum and minimum values;
• typical price, which is the arithmetic average of such numbers: closing price, maximum and minimum;
• the weighted price is the average of four numbers: the high, the low and the two closing prices.

How to apply the RSI technical analysis indicator, description and calculation of the Relative Strength Index: https://youtu.be/q2uDPH8MizQ The trader can choose the option that suits more. The creator of the indicator believed that the optimal calculation period is 14 bars. Now the point of view is more popular, which suggests that it is better for a trader to choose the duration specifically for the instrument used. If it is shorter, then the number of signals will be greater, but many of them are false. The success rate is higher when the period is longer. However, such signals will occur less frequently.

RSI indicator settings

To configure, you need to set the following parameters:

1. Data processing period. In this case, you must specify the number of bars for which the calculation should be made.
2. You need to choose which bar price should be used. This is determined by the trading system the trader is using.
3. You need to set the levels, the crossing of which by the price will become a signal for the trader.

The determination of the length of a suitable period must be chosen precisely. If it is too short, then the trader will receive a large number of signals, from which it will be difficult to choose sufficiently reliable ones. With a very long duration, the indicator chart will cross the signal levels relatively rarely.

It is believed that on smaller timeframes the noise level will be higher, which may require an increase in the duration of the calculation period. It is interesting to note that the author of the indicator considered 14 to be the best period for various timeframes. Currently, 9 and 25 are also popular.

There is a rule, following which, you can empirically find the desired duration. To do this, you need to set this parameter in the indicator settings and see on the chart what signals it gave. If 80-90% of such signals are confirmed by the corresponding price movement, then the selected parameter will be effective. If this is not the case, then it is recommended to perform the same check for another number. You need to choose the right signal levels. They divide the chart into three zones. If the price crosses the lower signal level from top to bottom, then we can talk about the oversold zone. When a higher level is crossed from the bottom up, an overbought zone begins. The most popular levels are 20, 30, 40, 50, 60, 70, 80. The trader needs to choose those that he considers the most effective.

How to Use the RSI Divergence Indicator – Strategy and Rules

There are several ways to work with RSI. Perhaps the most famous of these is the definition of overbought or oversold. When deciding on a trade, it will be useful to examine not only the current, but also a larger time frame. If the signals are unidirectional, this will increase the likelihood of a profitable trade, and if there is a divergence, the risk of losses will increase. The most effective way is to trade in accordance with the current trend direction. In this case, only transactions in his direction are considered. For example, in a downtrend, you only need to open transactions to sell assets. In the case under consideration, the indicator signal will be the exit of RSA from the oversold zone. For the opposite direction of the trend, the signal will consist in exiting the overbought zone. In its classic form, the oscillator is most effective when used for a sideways trend. For growing, levels are used that are shifted up relative to the classical one. For a falling one, you need to move them lower.
This technique is also used for trading against the trend. This option is best used by more experienced traders. If the quotes of the exchange asset are in an uptrend, then to enter a sell deal, you must wait until the indicator crosses the upper signal line from top to bottom, leaving the overbought zone.
When considering a downtrend, do the same. In this case, the signal to enter into a sell deal will be the indicator crossing the larger signal line from top to bottom. You can use the indicator to recognize the presence of a trend. A growing RSI will be indicated by a long stay in the upper half of the chart (a value greater than or equal to 50). For a descending one, it is necessary to consider the situation when the indicator does not exceed 50. An important filter for making transactions is determining the direction of the trend. The indicator in question provides a way to do this. In this case, the line at level 50 is considered. A long stay of RSI on one side of it indicates that the price is in a trend. This line can often serve as a resistance or support line in a trending move. Another use of the indicator is the failed swing formation. Next, we will consider a situation favorable for a deal to sell. In order to recognize it, the following signs must be present:

1. The RSI indicator crosses the upper signal line, thereby entering the overbought zone.
2. Being in it, he demonstrates a peak up.
3. After a slight temporary decrease, it makes another such peak, but its height should be less than that of the first one.
4. At the same time, the price goes up.

This situation suggests that the price of shares in the future is likely to decrease. In this situation, there are high chances to profitably enter a deal to sell securities. Failed Swing Formation:
Despite the fact that the growth continues, the “failed swing” pattern demonstrates the weakness of the existing movement. It shows that a new trend may soon begin. Here we consider the situation for a growing trend. The immediate signal is the crossing of the horizontal bottom line on the RSI chart, from which the second peak begins. For decreasing reasoning, the argument is carried out in a similar way. It must be remembered that although we are talking about a significant probability of success, nevertheless, we are not talking about a complete guarantee of a change in trend. This technique is also called divergence. Some experienced traders consider this signal to be relatively reliable. In order to use it, it is recommended to wait for the beginning of the confirming price movement.
Another type of signal is the presence of a trend on the indicator chart. If you draw a straight line along the ledges or troughs, then when it crosses, you can expect that on the chart it will also be possible to enter into a deal in the corresponding direction. At the same time, the presence of an indicator trend does not mean that it will be similar on the chart. Some traders consider it fruitful to study the indicator chart from the point of view of technical analysis. For example, they can use such signals as flags,
triangles , “head and shoulders” and others on it, interpreting them in the same way as on the price chart.
It is interesting to note that the presence of these figures on the RSI chart does not mean that they can be found on the price chart at that time. Despite this, the use of these types of signals will help to find profitable trade opportunities.

When to use RSI and when not to

The correct choice of signal lines plays an important role. It should correspond to the features of the instruments and timeframes used. Choices of 30 and 70 work well in calm markets. It can also be used on higher timeframes. If the market is bullish, then the levels will not be symmetrical. One of the suitable options is to choose 40 and 80. For a downtrend, you need to shift the levels down. For example, 20 and 60 may be suitable. It is best when the trader selects these signals in such a way that they are suitable for working with the selected instrument.
It should be borne in mind that the indicator signals in most cases indicate a change in trend. It must be remembered that the result is not always the opposite trend. Sometimes a lateral movement may occur, which will last for a relatively long time. Therefore, the decision to enter a trade should be made when the price movement confirms the beginning of the desired trend movement.
When using RSI, it is important to increase the likelihood of entering a profitable trade. To do this, it is beneficial to use it together with others. It is advisable to use trend indicators for this. For example, in this situation, MACD or
moving average may be suitable.. With their help, the trend will be determined, and when using the RSI, it will become clear when you need to directly enter the deal. Signals to enter a trade to buy stocks in a bull market:

Pros and cons

Using the Relative Strength Index allows you to enjoy the following benefits:

1. This indicator allows the trader to receive reliable overbought and oversold signals for almost any type of exchange assets.
2. Retains its effectiveness when applied on any timeframes.
3. Can be used in any trading sessions.
4. It can be used in various ways, including to determine the direction and strength of a trend, to determine the entry point into a trade.
5. High speed of reaction to price behavior.
6. With the correct interpretation of the indicator readings and its signals, RSI can be considered an accurate signal.
7. In the course of work, the trader receives enough signals to be able to choose the most suitable ones for making transactions.

To use it correctly, it is necessary to take into account the following disadvantages:

1. If the calculation period is too short, then the number of received signals will increase sharply, in which it will be more difficult to navigate. In this case, you will have to use effective means to filter them.
2. With long-term trends, the indicator signals may be ambiguous.
3. In this tool, line intersections are most important, but the behavior of the indicator chart in other cases can be difficult to correctly interpret.

In order to use the indicator as efficiently as possible, the trader must take into account all its important features when analyzing.