Relative Strength Index
The Relative Strength Index (RSI) developed by J. Welles Wilder, is a momentum oscillator that measures the speed and change of price movements. RSI oscillates between zero and 100. It is intended to chart the current and historical strength or weakness of a stock or market based on the closing price of a recent trading period.
The RSI is most typically used on a 14 day time frame. As a general rule, an overbrought condition exists when the relative strength reaches 70-80, and an oversold condition exists when the relative strangth declines to 20-30, although in both cases, these figures are general guidelines and can be extended even further up or.
Wilder posited that when prices moves up very rapidly, at some point it is considered overbrought. Likewise, when price falls very rapidly, at some point it is considered oversold. In either case, Wilder deemed a reversal imminent.
Wilder further believed that divergence between RSI and price action is a very strong indication that a market turning point is imminent. A bearish divergence occurs when price makes a new high but the RSI makes a lower high, as in the chart below. A bullish divergence occurs when price makes a low but RSI makes a higher low.
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