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What's Inside Relative Strength

Aug 11, 2008
When stated in a mathematical sense, RSI seems more difficult than it actually is to both use and understand. To evaluate the relative strength by hand, the trader must know the formula for doing so. The RSI is simply 100 minus the quotient of 100 divided by 1 plus the relative strength. Relative strength is equal to the average gain divided by the average loss. The average loss should be stated in a positive number to make this work.

After looking at the math, it's no wonder that professional traders use computers to decipher the RSI. Short, quick trading, such as scalping or day trading, would never allow the time needed to make these calculations on each bar.

Understanding RSI and how it works though is very important; it is one of the most popular oscillators and even one of the most profitable indicators, if used correctly. Many professional traders use the RSI in the form of convergence or divergence, momentum trading, or to show trends and produce consistent profits.

Best kept secret

The RSI might just be one of the best kept professional insider secrets. Relative strength is nothing more of an idea, but its refinement by J. Wilder kept the index very popular, especially after computerized trading began. There are many profitable ways to use the Relative Strength to Price to give you an idea of future movement.

Use the RSI to find breakouts

Many traders like divergence as a good way to predict new trends. Depending on your personal trading style, you may find interest in following divergence while scalping or investing as it applies to any timeframe. The idea is that when the RSI diverges with the chart, the price is likely to soon follow in the direction of the RSI. Weakening strength, but a higher stock price, means that the price is going up on weakness and the market direction will change when momentum fades out.

Trading plan secrets

Others like to trade RSI as simply an oscillator. Developing a trading plan is made easier with at least one oscillator for conformation. Professional traders like to use oscillators as the indicator to seal the deal - if all the other requirements of a short position are made clear AND the oscillator is indicating a sell, the trader should follow through with the short position.

RSI is simple but should be considered

The RSI is a very simple indicator. It feeds on momentum and shows weakness before other back testing models. Any trader can find a way to fit the RSI into their own trading style, as it has so many applications for forecasting stock prices.
About the Author
Leroy Rushing is an active, professional day trader; trading coach; and author. He is the Founder and CEO of Trading EveryDay, a distinguished provider of educational trading products and services that are available worldwide. Trading EveryDay has complimentary/FREE products, a Tools of the Trade eBook and a Trading Room Report , that are downloadable for your convenience.
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