Relative stärke index

What Is Relative Strength Index?

The Relative Strength Index (RSI) is a prominent momentum oscillator used in technical analysis that measures the speed and change of price movements. Developed by J. Welles Wilder Jr., this indicator provides insights into whether an asset is overbought or oversold, typically plotted as a line graph oscillating between zero and 100. The Relative Strength Index helps traders and investors assess the internal strength of a security and anticipate potential reversals or continuations of market trends.

History and Origin

The Relative Strength Index was developed by J. Welles Wilder Jr., a mechanical engineer, and first introduced to the public in his seminal 1978 book, New Concepts in Technical Trading Systems.¹³ Wilder aimed to create a more reliable and standardized tool for measuring price strength than existing momentum indicators, which often produced erratic signals. His innovative approach smoothed price data and scaled the result into an oscillator, making the Relative Strength Index a cornerstone of modern technical analysis. The indicator quickly gained widespread adoption due to its systematic design and accessibility for both novice and experienced traders.¹²

Key Takeaways

• The Relative Strength Index (RSI) is a momentum oscillator within technical analysis that measures the speed and change of price movements.
• It oscillates between 0 and 100, typically using a 14-period setting.
• Readings above 70 generally indicate an overbought condition, while readings below 30 suggest an oversold condition.
• Traders use the Relative Strength Index to identify potential price reversals, confirm existing trends, and spot divergence between price and momentum.
• Like all technical indicators, the Relative Strength Index is most effective when used in conjunction with other analytical tools and approaches.

Formula and Calculation

The Relative Strength Index (RSI) is calculated in two main steps. First, the Relative Strength (RS) is determined, which is the average of upward price changes (gains) divided by the average of downward price changes (losses) over a specified period, typically 14 periods.

1. Calculate Average Gain and Average Loss:

   • Average Gain = (\frac{\text{Sum of Gains over N periods}}{\text{N}})
   • Average Loss = (\frac{\text{Sum of Absolute Losses over N periods}}{\text{N}})
   • Note: For initial calculation, a simple average is used. For subsequent periods, a smoothed moving average is applied.

2. Calculate Relative Strength (RS):
   $RS = \frac{\text{Average Gain}}{\text{Average Loss}}$

3. Calculate Relative Strength Index (RSI):
   $RSI = 100 - \left( \frac{100}{1 + RS} \right)$

Here, N typically represents 14 periods (e.g., 14 days, 14 hours). The Average Gain accounts for periods where the closing price increased, and the Average Loss accounts for periods where the closing price decreased. For periods with no change, both are zero. The formula ensures the Relative Strength Index always falls within a range of 0 to 100.

Interpreting the Relative Strength Index

The Relative Strength Index provides numerical values that assist in interpreting price action and market sentiment. The most common interpretation involves specific thresholds:

• Overbought Conditions: An RSI reading of 70 or above typically indicates that a security may be overbought, suggesting that its price has risen too quickly and may be due for a downward correction or reversal.¹¹
• Oversold Conditions: Conversely, an RSI reading of 30 or below suggests that a security may be oversold, implying that its price has fallen excessively and could be due for an upward rebound.¹⁰

Traders also observe divergence between the Relative Strength Index and price, which can signal potential trend reversals. For example, if a stock's price makes a new high but its Relative Strength Index makes a lower high, this bearish divergence suggests weakening upward momentum. Additionally, the 50-level often acts as a centerline; a move above 50 can indicate bullish momentum, while a move below can signal bearish momentum.⁹ However, in strong trends, the Relative Strength Index can remain in overbought or oversold territory for extended periods, and traders may adjust the traditional 70 and 30 levels to 80 and 20 for such conditions.⁸

Hypothetical Example

Consider a hypothetical stock, "GrowthCo (GCO)," which has been experiencing a strong upward surge. A trader is monitoring GCO's 14-day Relative Strength Index.

• Scenario 1: Overbought Signal
  Over several days, GCO's price climbs rapidly, and its 14-day Relative Strength Index reaches 78. This reading is above the traditional 70 threshold, signaling an overbought condition. The trader, using this as a potential trading signal, might consider reducing their position or preparing for a potential price pullback. They would typically look for the Relative Strength Index to fall back below 70 as a confirmation of weakening momentum before acting.

• Scenario 2: Oversold Signal with Divergence
  Months later, GCO's price experiences a significant decline. Its price hits a new low of $25, but the 14-day Relative Strength Index, instead of hitting a new low below 30, only falls to 32 and then starts to tick up, forming a higher low than a previous oversold reading. This creates a bullish divergence, where price makes a lower low but the Relative Strength Index makes a higher low. This could suggest that the selling pressure is easing, and bullish momentum is subtly increasing, hinting at a potential upward reversal, even though the price is still dropping. A trader might then look for further confirmation, such as a breakout above a resistance level on the price charts, before considering a buying opportunity.

Practical Applications

The Relative Strength Index is a versatile technical indicator widely used in various facets of financial markets:

• Identifying Entry and Exit Points: Traders frequently use the Relative Strength Index to pinpoint potential entry and exit points. An oversold reading (below 30) might signal a buying opportunity, while an overbought reading (above 70) could suggest a selling opportunity or a time to take profits.⁷
• Trend Confirmation: Beyond identifying extremes, the Relative Strength Index can confirm the strength of an existing trend. In an uptrend, the indicator often remains between 40 and 90, with the 40-50 zone acting as support levels. In a downtrend, it typically stays between 10 and 60, with the 50-60 zone acting as resistance levels.⁶
• Spotting Divergence: One of the most powerful applications of the Relative Strength Index is identifying bullish or bearish divergence. This occurs when the price of an asset moves in one direction (e.g., making a new high) but the Relative Strength Index moves in the opposite direction (e.g., making a lower high), suggesting a weakening of the current price trend and a potential reversal.⁵
• Integration with Other Indicators: For increased reliability, traders often combine the Relative Strength Index with other technical indicators like Moving Average Convergence Divergence (MACD) or Bollinger Bands to filter out false signals and gain a more comprehensive view of market conditions.⁴ This integrated approach helps in developing a robust investment strategy.

Limitations and Criticisms

While the Relative Strength Index is a popular technical indicator, it is not without limitations. A primary criticism is its potential to generate false trading signals, particularly in strongly trending markets.³ In a robust uptrend, a security's Relative Strength Index can remain in overbought territory (above 70) for an extended period, leading to premature selling signals for traders who rely solely on the traditional thresholds. Conversely, in a strong downtrend, the Relative Strength Index can stay oversold (below 30) for prolonged durations, triggering early buying signals.

Academic research has also highlighted concerns regarding the consistent profitability of the Relative Strength Index when used in its standard configuration. One study, for example, found that using the common 30/70 thresholds for buy/sell signals on currency exchange rates yielded no trading profit and even a small loss over a decade, though altering the parameters could still lead to profits.² This suggests that while the formula itself is sound, its interpretation and fixed parameters may not always adapt to evolving market trends and volatility. Therefore, practitioners emphasize that the Relative Strength Index should not be used in isolation but rather as part of a broader risk management strategy, incorporating other analytical tools and market context.

Relative Strength Index vs. Relative Strength

While their names sound similar, the Relative Strength Index (RSI) and "Relative Strength" refer to distinct concepts in financial analysis. The Relative Strength Index is a momentum oscillator, specifically a single-asset technical indicator that measures the internal strength of a security by comparing its recent gains to its recent losses over a defined period. Its purpose is to identify overbought or oversold conditions within that single asset.

In contrast, Relative Strength (without "Index") is a comparative measure. It evaluates the price performance of one asset, sector, or market against another asset, sector, or a broader market benchmark (e.g., a stock compared to the S&P 500).¹ The goal of Relative Strength analysis is to identify which asset is outperforming or underperforming relative to another, rather than assessing internal momentum. Essentially, the Relative Strength Index looks inward at a security's own price action, while Relative Strength looks outward to compare its performance against something else. Confusion often arises because both terms incorporate the word "strength" and deal with price movement.

FAQs

What is a good Relative Strength Index (RSI) number?

There isn't a single "good" Relative Strength Index number, as its interpretation depends on the market context and investment strategy. Traditionally, a reading above 70 indicates an overbought condition, while a reading below 30 suggests an oversold condition. However, in strong market trends, the Relative Strength Index can remain in these extreme zones for extended periods. Some traders adjust these thresholds (e.g., using 80/20) or look for the Relative Strength Index to cross back out of these zones as a more reliable trading signal.

Can the Relative Strength Index predict future prices?

No, the Relative Strength Index, like other technical indicators, does not predict future prices with certainty. It is a lagging indicator that measures past price action to gauge momentum and identify potential overbought or oversold conditions. While it can provide insights into possible reversals or continuations of trends, it cannot guarantee future price movements. It is best used as a tool to inform trading decisions in conjunction with other forms of analysis and sound risk management.

What is RSI divergence?

Relative Strength Index divergence occurs when the price of a security moves in one direction, but the Relative Strength Index moves in the opposite direction. For example, a bullish divergence happens when the price makes a new low, but the Relative Strength Index makes a higher low. This can suggest that the selling pressure is weakening, and a potential upward reversal is approaching. Conversely, bearish divergence occurs when the price makes a new high, but the Relative Strength Index makes a lower high, indicating waning buying momentum and a potential downward reversal.