INDICATORS
Visual Variation On An Index
RSI Bands
by François Bertrand
In this twist on the traditional relative strength index, find out how it can be used as a visual analytical tool and with other technical indicators.The relative strength index (RSI) is a popular indicator to evaluate if a stock is overbought or oversold. However, its values range from zero to 100 and must be evaluated in a separate window, making its correlation with price and trends more difficult than other indicators that are overlaid directly on price charts such as the Bollinger bands.
In this article I present a way of calculating RSI bands, which trace RSI overbought/oversold levels directly over price data, making this indicator more intuitive to use and opening up new analysis and signaling possibilities.
CALCULATING RSI BANDS
RSI bands are calculated by answering the question, "What price should the stock have to reach today to be considered overbought/oversold, given yesterday's RSI?"
Each band corresponds to a certain level. Typically, 70 and 30 have been used as overbought/oversold levels, so we would draw one band for 70 and one band for 30. Because calculations are based on the original RSI calculations, bands can be drawn for any level and any period of time. If given extreme values (such as a very short period), however, the bands get very volatile. The addition of an optional clamping algorithm solves that problem.
The code used to calculate RSI bands can be found in the sidebar "AmiBroker code for calculating RSI bands."
ANALYSIS
Rsi bands provide a new, intuitive way of visualizing the RSI. In the chart of the Dow Jones Industrial Average displayed in Figure 1, we can immediately spot the precise overbought/oversold crossovers without having to use rulers or approximately correlate the bottom and top charts.
In addition, RSI bands also highlight obvious trouble spots that would have not otherwise triggered 70/30 crossover signals. These spots are obvious to the naked eye, because of the overall shape of the price or protruding highs/lows, but would not have been as obvious in a regular Rsi chart, probably dismissed as a generally low/high RSI.
...Continued in the April issue of Technical Analysis of STOCKS & COMMODITIES
Excerpted from an article originally published in the April 2008 issue of Technical Analysis of
STOCKS & COMMODITIES magazine. All rights reserved. © Copyright 2008, Technical Analysis, Inc.
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