37 Relative Strenght Index (RSI)

This index looks back over certain number of periods, and estimates the ratio between the number of times the price when up (gains) and the number of times the price when down (losses).

Basically, it is like the scoreboard of the war between longers and shorters.

This score ranges from 0 to 100. When the score is 50%, it means during the period analysed, the number of gains and losses have been the same.

When above 50% the longers are wining….values above 70% are called overbought. When the RSI is below 30% is called “Oversold”, the shorters are wining.

The blue line in the image below shows the RSI trend for a given stock.

Figure 8.53: RSI

Say you see RSI moving below 30% (the shorters are wining, image above), then it starts to move up….this is signalling that the longers are fitting back and gaining terrain in the war.

If we think this as a long term war, in which RSI has been consistently below 30% (shorters domination), and starts to go up, it could signal exhaustion by the shorters. It may indicate a good time to buy, as the price may just start to go up.

Focus now on the image below, showing price (upper plot) and (RSI) lower plot. Note how the RSI starts to fall down, and indication that the shorters are gaining terrain, as you may expect this leads to a price reduction.

Figure 8.54: RSI