Increasing Reliability
ARSI, The Asymmetrical RSI
The RSI has always been useful in identifying divergences. Here's a modification of this popular indicator that could be even more reliable.
The relative
strength index (RSI) is a momentum indicator measuring the speed at which
a security's price is changing. Early signaling for entry and exit points
is the main advantage of this leading indicator. The RSI calculation separates
one-bar net change over a defined period into positive closing prices and
negative closing prices, then smoothes that data with an average and finally
normalizes the ratio on a scale of zero to 100.
The RSI formula:
Where the relative strength (RS) equals:
The RS value is the average gain divided by the average loss over the selected RSI period.
For an up closing average, when the closing price of the present bar is higher than the previous one, the price difference is averaged based on the RSI period. J. Welles Wilder uses an exponential average of twice the RSI period minus 1.
The same is done for a down closing average or when the closing price
of the actual bar is lower than the previous bar (expressed in positive
values). This means that the averaging period has no relation to the number
of up or down bars in the RSI period. The RSI is converted into an oscillator
with values between zero and 100:
100 - (100/RS + 1)
DIVERGENCES
A standard 14-bar RSI is considered oversold when it is below 30 and overbought when it is above 70. One of the most valuable ways to utilize the RSI is to watch for divergences with price. A divergence describes a situation where the trend of the oscillator moves in a different direction from the prevailing price trend. Here are some possible divergence situations:
1. When the oscillator creates a higher bottom while price makes a lower bottom. This is mostly found at the end of a downtrend, indicating an uptrend reversal....Continued in the October issue of Technical Analysis of STOCKS & COMMODITIES2. When the oscillator creates a lower top while the price makes a higher top. This is mostly found at the end of an uptrend, indicating a downtrend reversal. These divergences are commonly known as normal divergences.
Excerpted from an article originally published in the October 2008
issue of Technical Analysis of STOCKS & COMMODITIES magazine. All rights reserved. © Copyright
2008, Technical Analysis, Inc.
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