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The Relative
Strength Index (RSI) is a popular momentum
oscillator that was developed by J. Welles Wilder.
The RSI compares the magnitude of a stock or
index's recent gains to the magnitude of its recent losses and converts this
information into a number that ranges from 0 to 100. Below is an example
of the DOW index with its 20, 50, 100 and 200 day simple moving averages (SMA), and its RSI
oscillator.
There are a few ways to interpret and use the RSI:
Oversold/Overbought:
If the RSI falls below 30 the stock/index is oversold, and if the RSI
rises above 70 it is overbought. Additionally, if the stock/index trends
above 30 it is considered a bullish signal, and if the RSI trends below 70 it is a
bearish signal. Some traders identify the long-term trend of a stock/index
and then use extreme readings of the RSI as entry points. For example, if
the long-term trend of a stock/index has been bullish, then a temporary RSI
reading near 30 could mark a potential entry point.
Centerline crossover:
The centerline for RSI is 50. A reading above 50 indicates that
average gains for the stock/index 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.
As we can see for the DOW index chart above, the RSI dipped
below 50. As a result, the RSI is telling us that average losses have been
higher than the average gains over the last few weeks and sentiment is currently
slightly bearish.
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