The Relative Strength Index (RSI)
Relative Strength Index (RSI) is used to gauge the strength of a stock. This indicator compares the number of days that a stock finishes up and down. This is a very common indicator used by momentum traders.
The RSI is a reasonably simple model that anyone can use. It is calculated using the following formula.
|RSI = 100 - [100/(1 + RS)]
RS = (Avg. of n-day up closes)/(Avg. of n-day down closes)
n= days (most analysts use 9 - 15 day RSI)
The RSI ranges from 0 to 100. At around the 70 level, a stock is considered overbought and you should consider selling. If the RSI approaches 30, a stock is considered Oversold and you should consider buying.
The smaller the number of days used, the more volatile the RSI is and the more often it will hit extremes. A longer term RSI is more rolling, fluctuating a lot less. Different sectors and industries have varying threshold levels when it comes to the RSI. Stocks in some industries will go as high as 75-80 before dropping back, while others have a tough time breaking past 70.
Click To Enlarge
This chart was supplied by Barchart.com
Above, we have an RSI chart for AT&T. The RSI is the green line, and its scale is the numbers on the right hand side that go from 0 to 100. Notice the RSI was approaching the 60-70 level in December and January, and then the stock (blue line) sold off. Also, notice that when the RSI dropped to 25 around October the stock climbed up nearly 30% in just a couple of weeks.