The RSI (Relative Strength Index) was introduced in a 1978
book by J. Welles Wilder and has become one of the most popular momentum
oscillators in use today.
The RSI compares the magnitude of recent gains to the
magnitude of recent losses, representing the results in a range between 0
and 100. The RSI is calculated by means of the following formula:
RSI = 100 - 100/(1 + RS)
Where RS is a ratio between the average gains and average
losses over a specified period:
RS = (Average Gain) / (Average Loss)
One of the most popular periods (and a setting recommended
by author of the RSI) to calculate the average gain and loss is 14 bars.
However, it is important to remember that the Average Gain and Average Loss
are not true averages! Instead of dividing by the number of gaining (losing)
periods, total gains (losses) are always divided by the specified number of
time periods - 14 in this case.
70 and 30 are the most commonly used RSI levels for a
market considered "overbought" or "oversold", respectively. Basically, the
RSI is a measure of the strength of a recent trend:
If the 14-day
RSI is greater than 70, the security has trended up strongly over the
past 14 days and the RSI is considered strongly bullish. Some would
consider the security to be overbought at these levels. An RSI greater
than 70 could thus mark a potential selling point;
If the 14-day
RSI is between 50 and 70, the security has moved up over the past 14
days; however, the uptrend has not been very strong;
If the 14-day
RSI is between 30 and 50, the security has moved down over the past 14
days; however, the downtrend has not been very strong;
If the 14-day
RSI is below 30, the security has trended strongly lower over the past
14 days and the RSI is considered strongly bearish. Some would consider
the security to be oversold at these levels. An RSI below 30 could thus
mark a potential buying point.
About PVO
The 1/9 PVO (Percentage Volume Oscillator) shows how
recent daily volume production compares to the average volume generated over
the past 9 trading days.
A 1/9 PVO value greater than 1.15 indicates a volume
surge that exceeds the average volume output over the past 9 trading
days by 15%.
How to use the RSI
and our Volume Indicators
The market will not always reverse when the RSI exceeds 70
(or when it trades below 30), just as the market will not always turn when
we see volume surges. However, the probability of a reversal is much
higher when volume surges occur in conjunction with a strong market advance
or decline.
The simple trading system below is based on the RSI and
volume indicators; it can be used to trade the market successfully:
Sell on a significant volume surge when the RSI rises
above 70.
As a rule, Volume Surges (indicated by a high PVO) that appear during a
strong index advance - (i.e., when the RSI > 70) - indicate potential
downside reversals;
Buy on a significant volume surge when the RSI drops
below 30.
As a rule, Volume Surges (indicated by a high PVO) that appear during a
strong index decline (i.e., when the RSI < 30) - indicate potential
upside reversals;
Ignore Volume Surges that appear when the RSI remains
between 30 and 70. Market reactions could be short-lived.
