Technical analysis II

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21. Relative strength indicator

The Relative Strength Indicator (RSI) was developed by J. Welles Wilder in the late 70s and, like Price Minus Average, it compares the current price of a share with its past price history.

Wilder observed that shares on a rising trend tend to close each trading session near their daily high, and those on a descending trend tend to close near their daily low. He reasoned that if you compare recent daily rises with daily falls, you should be able to see which of the two forces was dominating i.e. their relative strength.

The formula for RSI is:

Welles Wilder used 14 days as his 'N' figure, but chartists nowadays commonly use 9 days and 25 days. The shorter the figure you use, the more volatile your chart will be.

Frankly, you don't need to worry too much about the mathematical jiggery-pokery. Any good technical analysis software package will plot RSI for you, and what you really need to know is how to extract buy/sell signals from the chart.

The basic rules are:

• If the RSI goes above 70 the shares are overbought, and you should consider selling at that price level.
• If the RSI goes below 30 the shares are oversold, and you should be looking for buying opportunities.

A relative strength indicator

Note that one of the features of RSI is that all the values are in the 0 - 100 range on the Y axis.

The other way RSI is used is in comparison with the share price chart. If the share price hits a new high or low, but the RSI chart doesn't follow suit, that's known as a "divergence" and when you get a divergence, the theory is that the share price will correct itself and move with the RSI.

In general RSI is a popular indicator and considered one of the most reliable of all. But it works best with shares which are volatile and have plenty of movement. It is not so good with quieter shares.

1. Average share prices 2. Moving averages 3. Weighted moving averages 4. Where to plot moving averages 5. Interpreting moving averages - the basics 6. Classic interpretation of moving averages 7. Combining short and long term moving averages 8. Moving average convergence/divergence (MACD) 9. Reversal patterns 10. Head and shoulders top 11. Head and shoulders bottom 12. Double top 13. Double bottom 14. Rounding tops and bottoms 15. Broadening formations 16. Wedge formations 17. The momentum indicator 18. The momentum oscillator 19. Rate of change indicator 20. Price minus average 21. Relative strength indicator 22. Conclusion

• Martin Pring's Introduction to Technical Analysis: Seminar and Workbook
• Technical Analysis Plain and Simple
• Technical Analysis of the Financial Markets
• Technical Analysis