Relative Strength Index

This oscillator was developed by J Welles Wilder, Jr. He points out that there are two difficulties using the momentum line: 1. sharp change in prices on a particular trading day can cause and sudden erratic movements in the momentum line. Some smoothing is required to minimize these distortions. 2. A constant range is required for comparison purposes – this is solved by creating a vertical range of 0 to 100. How to use the Oscillator: 1. RSI is plotted on scale of 0 to 100. Movements above 70 are considered overbought and movement below 30 is considered oversold. It should be noted however that in a trending market the oscillator could quickly go to these levels and stay there. This movement alone should not be an indicator of entering or exiting a position. 2. Wilder considers the single most indicative characteristic of the RSI as the divergence between the market and the oscillator when it is trading above 70 or below 30. Wilder called these “failure swings”.

The chart shows the weekly chart of EURO Stoxx 50 index (from 2013 to 2019) with a 14 week RSI oscillator above it.

Two occasions of “failure swings” is seen on RSI, one generating a buy signal and another generating a sell signal.