Overview

The Relative Strength Indicator was developed by Welles Wilder in 1978, and depicts the relative changes between the higher and lower prices. It is an oscillator because the indicator's values vary between 0 and 100.

Calculation

The formula used to compute RSI is:

Where:

• t is a particular point in time
• n is the number of time periods specified at the time of the RSI request

And where:

These values cannot be calculated for the initial periods of a chart (0 to n-1), until the number of time periods passed is n. Then the first calculation is: Where u is any increase from opening to close for a particular time period. (If there's a decrease, the value of u for that period is considered 0.) That is,

These values cannot be calculated for the initial periods of a chart (0 to n-1), until the number of time periods passed is n. Then the first calculation is: Where d is any decrease from opening to close for a particular time period. (If there's an increase, the value of d for that period is considered 0.) That is,

Parameters

The RSI indicator has one key parameter:

• n, specifying the number of periods to include in the calculation  (Wilder recommended the use of 14 for n, while others use 9 or 25),

and two minor parameters used to highlight overbought/oversold conditions

• an overbought threshold, with 70 being the default
• an oversold threshold, with 30 being the default.

The area in the graph above the overbought threshold and below the oversold threshold is shaded.

Interpretation

The RSI indicator is typically interpreted in three different ways:

• Overbought/oversold signals: The area in the graph below 20 is typically interpreted as an oversold region, while the area above 80 is interpreted as an overbought region.  Some interpret the RSI falling below 80 as a sell signal and the RSI rising above 20 as a buy signal.
• Centerline crossover signals: This interpretation is based on the observation that a price in an upward trend tends to close nearer to the highs than the lows. When RSI is above 50, then the average gains are higher than average losses, and when the RSI is below 50, then the average losses are higher than the average gains. Hence, when the RSI crosses 50 in a downward direction, then this could be interpreted as a sell signal (especially if it confirms signals from other indicators), and conversely, when the RSI crosses 50 in an upwards direction, then this could be interpreted as a buy signal.
• Divergence signals: If the RSI and the corresponding exchange rates diverge in their directions, then this could be interpreted as a signal. Hence, if the rate is going up while the RSI is going down, then one might expected that the rate will soon change direction and start going down. Conversely, if the RSI is going up while the corresponding rate is going down, then one might expect the exchange rate to soon change direction and start going up.