UK Accounting Glossary
The Relative Strength Index (RSI) is a technical momentum indicator that compares the size of recent gains to recent losses in an attempt to determine overbought and oversold stock price.
The Relative Strength Index is calculated by dividing the average upward price changes by the average absolute price change. The price changes are determined by comparing the current close to the previous close. The RSI takes one input parameter which is the number of days used to average the up and down price changes.
The Relative Strength Index is typically viewed as a means of either confirming or denying price movements. The RSI can be used to time long entry by waiting for the RSI to rise above a certain threshold, 20% for example. The RSI can be used to time short entries or close long positions by waiting for the RSI to fall below a certain threshold, 80% for example.
The Relative Strength Index is a popular price-following oscillator that ranges between 0 and 100.
The Relative Strength Index compares, not the relative strength between two securities, but the internal strength of a single issue. A popular method of interpreting the Relative Strength Index is to look for divergences, such as when the price of the security is making a new high, but the Relative Strength Index fails to surpass its previous high. A divergence between price and the Relative Strength Index would be an indication of an impending reversal.
The Relative Strength Index usually tops out above 70 and bottoms out below 30.
Further, the Relative Strength Index displays similar chart patterns to price movement that might not yet be apparent in the price charts. Support and resistance penetration of the Relative Strength Index can warn of a changing price trend. Investors use the Relative Strength Index as a forecasting tool when it diverges from price action and they also watch for hooks on the 70 line and the 30 line to generate buy/sell signals. The Relative Strength Index equals 100-100/(1+Average up gains for X periods/Average down gains for X periods).
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This glossary post was last updated: 6th February 2020.