"Relative Strength Index Is Your Guide To Market Direction...

And More!"

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**Relative Strength Index,** or

**RSI,** is a momentum based oscillator. Not to be confused with the

**relative strength comparison method,** the RSI compares a

**stock's recent gains to its recent losses.**The RSI was first introduced by Welles Wilder in his 1978 book,

*New Concepts in Technical Trading Systems.* Wilder chose a

**14-day look back period** which is derived by taking half of the 28-day lunar cycle.

The relative strength index is calculated by taking the **sum total of gains for a 14-day period and dividing it by the sum total of losses for the same 14-day period.** The formula looks like this...

In order to create an **oscillator that moves between 0 and 100,** the following formula is applied...

There are many ways to interpret the relative strength index.

First, it can be used as an **over-bought/over-sold indicator.** Wilder used 70 and 30 to mark these levels.

If the **indicator rises to 70,** then turns down, it is considered a **bearish sign.** Conversely, if the indicator moves to **below 30** and then turns up, it is taken as a **bullish sign.**

Additionally, the **crossing of the 50 line** may confirm a trend change. However, experience shows if the RSI oscillates **between 80 and 40 the stock is in a bullish mode.** If it bounces **between 60 and 20... it's bearish.**

### "How is the Relative Strength Index applied?"

**A powerful way to use the relative strength index** is by letting it **signal possible price reversals.** This is done by identifying areas where the **price of the stock diverges from the value of the RSI.**

There are four **types of divergences: bullish, bearish, positive and negative.** At first, this may sound redundant... but, the latter two have some **predictive value** and are best explained through chart examples.

Taking a closer look, **bullish and bearish RSI divergences are very common.** The following illustration shows how they work...

**Click Here for Bullish and Bearish Reversal Chart Examples**

Author and trader, **Andrew Cardwell discovered two other types of divergences which he called positive and negative.** These divergences are found in every phase of a stock's movement... whether it's **trending or range bound.**

The beauty of positive and negative divergences is their **ability to forecast price movement.**

First, locate positive and negative reversal patterns in the RSI and label the troughs and peeks like this...

**Using the corresponding closing prices,** plug them into the following formula to get the new **up-side price target...**

**( X - W ) + Y = price target**

**A down-side price target can be calculated** using the negative reversal pattern. Label the peeks and trough on the RSI. Then, using the closing price, calculate the price objective with this formula...

**Y - ( W - X ) = price target**

**Click Here for Positive and Negative Reversal Chart Examples**

Finally, the relative strength index can be used to **identify whether a stock is trending or is trading in congestion.** By applying moving averages to the RSI and the stock's price, you can determine the likely movement of the stock.

In the following chart, a **9-period simple moving average and a 45-period exponential moving average** have been applied to **both the price and the RSI of the stock.**

Use these rules to **determine whether the stock is trending or is in congestion...**

**IF:** Price 9-SMA **>** Price 45-EMA AND RSI 9-SMA **>** RSI 45-EMA

**THEN:** Trend is **up.**

**IF:** Price 9-SMA **<** Price 45-EMA AND RSI 9-SMA **<** RSI 45-EMA

**THEN:** Trend is **down.**

**IF:** Price 9-SMA **>** Price 45-EMA AND RSI 9-SMA **<** RSI 45-EMA

**THEN:** Trend is **sideways to up.**

**IF:** Price 9-SMA **<** Price 45-EMA AND RSI 9-SMA **>** RSI 45-EMA

**THEN:** Trend is **sideways to down.**

The **Relative Strength Index** is a **simple, yet powerful indicator** that should be consulted prior to trading. For a more comprehensive look at the RSI, **purchase the following books...**

**New Concepts in Technical Trading Systems**

**by Welles Wilder, Jr.**

Trend Research

1978

140 Pages

**Get This Book, Now!**

**Technical Analysis for the Trading Professional - Strategies and Techniques for Today's Turbulent Financial Markets**

**by Constance Brown**

McGraw-Hill

1999

341 Pages

**Get This Book, Now!**

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