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Introduction
The RSI was developed by J. Welles Wilder, Jr. as a measure of the market's strength or weakness. The principle idea of this study is that it will indicate a general zone that the market is in, either the buy zone or the sell zone. This indicator is similar to Stochastics in that it shows regions of overbought and oversold. This indicator should be incorporated into a system rather using it by itself. Wilder's popular indicator is known for its accuracy and its ability to compensate for erratic price movement.

Interpretation
RSI computes the difference in recent prices as a solid line and plots this line on a scale similar to the scale used by Stochastics. The area above 70 is generally considered to be the overbought region, and the region below 30 is referred to as the oversold region. Simply selling in the overbought region and buying when the RSI is in the oversold region is not a consistent method of trade. Trade signals are not generated until the RSI leaves these regions. So a sell signal would not be present until the RSI has begun sloping down and leaves the 70 region.

A buy signal, in the simple methodology associated with this pattern, is derived when RSI leaves the oversold region - crosses from below 30 to above it. Just like sell signals, RSI buy signals are present when the market begins to turn and the indicator leaves the oversold region.

Another use of the RSI is to look for a divergence in prices. For instance, when a market makes higher highs or lower lows and the RSI fails to follow suit. This difference in the indicator and the market could be a signal that the market lacks the momentum to continue its current price direction. So, you may be able to take a position sooner using this strategy, than you would with the previous way. Wilder says that this divergence is "the single most indicative characteristic of the RSI."

In its calculation the RSI indicator uses a moving average of price changes over the period. You can select which type of moving average is used to produce the desired amount of smoothing on the RSI indicator.

Example of the RSI in the Indicator Window:


Calculation
Parameters:
Period (14) - the number of bars, or period, used to calculate the study.

Formula:
The RSI computations are not difficult, but they are tedious. You first calculate the difference between the current closing price and the previous closing price. The general formula is:

DIFt = Closet - Closet-1

If that difference is a positive value, it is an up period, which means the current close is higher than the previous close. If the difference is negative, it is a down period, which means the current close is below the previous close. The DOWN value is always a positive number for all computations. It is the absolute value of a negative DIF. The worksheet below shows the calculations needed to create a 9 period RSI.
 

You now compute the up and down averages, which are calculated as follows:

Ut = (UP1 +... + UPn) / n
Dt = (DOWN1 +... + DOWNn) / n

UT: The up average for the current period.
DT: The down average for the current period.
UPn: The UP value for the nth period.
DOWNn: The DOWN value for the nth period.
n: The number of periods for the RSI.

Now, use the values from the worksheet. The up average is:
U = 60 / 9
= 6.67

and the down average is:
D = 35 / 9
= 3.89

The general formula for the RSI is:

RSIt = ( UT / (UT + DT) ) * 100

If you use the above values and place them in the formula, it appears as follows:

RSI = ( 6.67 / ( 6.67 + 3.89 )) * 100
= 63.16

Assume the market continues the downward trend. The next DIF value is -15, which sets the UP value to 0, zero, and the DOWN value to 15. Calculate the next up and down average by using Wilder's accumulative moving average technique. The formulae are:

UT = ( (UT-1 * (n-1) ) + UPt) / n
= ( (6.67 * (9 -1) ) + 0) / 9
= 5.93

DT = ( ( DT-1 * (n-1) ) + DOWNt) / n
= ( ( 3.89 * (9 - 1) ) + 15) / 9
= 5.12

The value for the new RSI equals the following:

RSI = ( (5.93) / (5.93 + 5.12)) * 100
= 53.67

Customizing
To change the settings of this indicator, open the Program Options screen by clicking the "Program Options" button located on the main Toolbar.



See the Program Options section for more details on changing the settings.