Here, one of the most popular indicators found in most analytical software packages is explained.
When the relative strength index (Rsi) became popular in the 1980s, it was touted as the indicator that led every turn in the market. Indeed, for certain futures contracts, financials and currencies, it could be prescient: In those markets, it had the peculiar ability to turn just as the financials would find a level of support or resistance before taking off to another price level.On other items, say, pork bellies or corn or cocoa, it would ape the price swings precisely. However, on trending prices, it would go up the limits of its excursion and bounce around there for weeks or months until the trend finally reversed. For stocks, its performance could be all over, depending on the trading characteristics of the stock in question.
Clearly, this was an indicator with promise but tricky implementation.
ONE OF A CLASS
J. Welles WilderÕs relative strength index is one of a class of indicators known as oscillators. These indicators bounce around (or oscillate) between fixed extreme values based on price movement or position of close in range or change in price over time. In the case of Rsi, the values can range from zero to 100 but typically fall between 20 and 80. Like many mainstays, the Rsi was introduced in WilderÕs New Concepts in Technical Trading Systems. There, Wilder outlined its strengths, including three that I think make it the best overall indicator:1 Excursions beyond 70 and 30 are setups for tops and bottoms.2 Chart formations that arenÕt apparent on the price chart are clear in RsiÕs line format.
3 Divergence between Rsi and price is a clear warning of imminent reversal.
Figure 1: Bond Action. An RSI set for 14 days ably picks off bond market turnarounds. The actual value chosen for RSI isnÕt magical Ñ your eye will adjust to how any value distills price charts into definitive pictures.
