• Student of Technical Analysis

RSI - How RSI is Calculated ? Ultimate Guide

In this article, We will discuss all about RSI, how RSI is calculated and how to trade with RSI.

Let's first understand what is RSI - relative strength index, and then know how RSI is calculated.


what is rsi? RSI EXPLAINED


How RSI is calculated, RSI formula, RSI Indicator

RSI - Relative strength index is a momentum showing indicator, commonly used by technical analysts to perform technical analysis. RSI shows the intensity of price changes over a particular period of time.


RSI was developed by J. Welles Wilder Jr.


RSI is a line graph which moves between a high and a low depending on the changes in price over a particular period of time.


The standard usage of RSI in technical analysis is like stated below:

  • Standard time period for RSI calculation : 14

  • Standard RSI overbought condition is when RSI reads above 70

  • Standard RSI oversold condition is when RSI reads below 30

However, it all depends on the trader and the strategy. There are thousands of traders who use customized setting for RSI based on their experience and back testing.


We personally use level 80 as overbought condition, and level 20 as oversold condition.


Now, Let's get right into RSI calculation formula and learn how RSI is calculated.


HOW RSI is calculated - FORMULA


Below is the formula for calculating RSI,


RSI = 100 – 100 / ( 1 + RS )


where,


RS = Relative strength = AvgGain / AvgLoss


AvgGain = average of all HIGHS in period N


AvgLoss = average of all LOWS in period N


N = Period of RSI (generally 14)


RSI can be plotted using these values.

if the number of highs are more, naturally, value of RSI will be higher and vice versa.

The next set of calculations once the next 14 periods are available smooths the calculations.


if the number of highs are more, naturally, value of RSI will be higher and vice versa.


Remember, RSI value will never go beyond 100, and never go below 0. In other words, the lowest possible RSI value is 0, and the highest possible RSI value is 100.


Now that you know how RSI is calculated, Do you need to calculate RSI every time on every chart? A BIG FAT NO! Thanks to automation, every forex broker and trading platform automatically calculates this for you. It is just wise to know how RSI is calculated, because it is foolish to invest your money using an indicator, even without knowing how it is calculated.


Now, Let's Learn how to trade with RSI and it's limitations.


HOW to trade with RSI ?


A bitter truth, before we see how to trade with RSI. The accuracy is too too low when you trade just with RSI based on oversold and overbought readings!


Never, ever, trade RSI in isolation - that is, never trade only based on RSI indicator oversold or overbought readings, use it just to analyze the market sentiment. so, what is the use of RSI then? how to trade with RSI? Read on.. You will not be disappointed :)


RSI Divergence

One of the methods of trading RSI is by spotting RSI divergence. What is RSI Divergence?

RSI divergence is a condition where,

  • the chart is showing higher highs, but RSI is showing Lower highs

  • the chart is showing lower highs, but RSI is showing higher highs

  • the chart is showing lower lows, but RSI is showing higher lows

  • the chart is showing higher lows, but RSI is showing lower lows

See the below figure, showing RSI divergence.



RSI divergence
RSI divergence


Now, the question is, Who is correct, the chart or RSI? The answer is, it is RSI!

when you spot RSI divergence, you have to believe RSI and not the charts. In short, RSI divergence catches the 'lies on the charts'.


For example,

if you see a lower high on the chart, but RSI is showing Lower high we have divergence! (Refer above Figure)

  • A trader who is not using RSI will SELL the instrument thinking that it is a lower high and chances are so high that, he will lose the SELL trade.

  • A trader who is using RSI indicator has spotted the RSI divergence, instead of SELLING, he will take a BUY trade, and chances are very high that, he will be profitable.


IMPORTANT PRO TIP: Always look for RSI divergence in TRENDY markets, and at the key levels, specially, Support and Resistance. The accuracy of trading RSI divergence is very high at support and resistance levels, and it is too low in the ranging markets.


TRADING RSI BREAKOUTS

Like trading RSI divergence, trading RSI breakouts is another high accuracy trading strategy every trader should know. In RSI breakout strategy, you look for the price to break out upwards or downwards from a trendline.


As shown in the figure below, RSI has broken out of the trendline giving a RSI buy signal. similarly, if you see RSI breaking down from a support trendline, then it is a RSI Sell Signal.



RSI Breakouts, rsi buy signal, rsi sell signal
Trading With RSI

THE BOTTOM LINE


RSI -relative strength index is a technical indicator showing the intensity in price changes. How RSI is calculated? - RSI is calculated using average gain and average loss over a time period. You should never trade only based on RSI overbought or RSI oversold conditions. RSI divergence & RSI Breakouts are two good trading strategies with good accuracy.


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