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The Essential Guide to RSI Indicator

by Coinwidow
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What is RSI indicator and how does it work?

The RSI (relative strength index) is a momentum indicator developed by J. Welles Wilder.

It oscillates between 0 and 100 and the purpose is to measure the “speed” of a price movement.

This means the faster the price goes up, the higher the RSI value (and vice versa).

Here’s the RSI Indicator formula…

RSI = 100 – 100 / [1 + RS]

Where RS = Average Gain / Average Loss

Wait!

Don’t let the math scare you because this isn’t as “scary” as it looks.

I’ll break this down that even a 10-year-old can understand.

Let’s get started…

How does the RSI indicator work?

As you can see, the only “tricky” thing is the RS calculation which is defined as…

Average Gain / Average Loss

In other words, the RSI indicator goes up when the average gain is large (or when the average loss is small).

Now you might be wondering:

“How does the value of the average gain goes up?

Simple.

When the price moves up quickly with little to no pullbacks, your average gain is large because the price is making positive gains—which leads to a higher RSI value.

Likewise, when the price tanks quickly with little to no pullbacks, your average loss is large because the price is making negative gains—which leads to a lower RSI value.

And finally…

The average gain/loss can be manipulated by the RSI settings.

For example:

  • If you choose a 14-period RSI, then the average gain (and loss) will be based on the last 14 candles
  • If you choose a 5-period RSI, then the average gain (and loss) will be based on the last 5 candles

So if you used a lower RSI period settings, the more sensitive the indicator will be to recent price movements (and it’s just the opposite for higher RSI period settings).

Make sense?

Here’s the RSI indicator in action (using the default 14-period RSI)…

RSI Indicator,Relative Strength Index

Now you might be wondering:

“Stochastic indicator vs RSI, what’s the difference?”

Well, they are similar but different.

I’ll explain…

The stochastic indicator and RSI are similar because they are both momentum oscillators.

In other words, they measure momentum in the market and their values range between 0 and 100.

But how are they different?

Well, the calculations that go into the stochastic indicator and the RSI indicator are different.

However, they use the same concept which is to measure momentum.

Thus, you shouldn’t be surprised to see both stochastic indicator and RSI pointing in the same direction (albeit with different values).

So, the bottom line is this…

If you want to use a momentum indicator (like RSI or Stochastic), just pick one will do because they pretty much tell you the same thing.

Moving on…



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