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PTMC team 04.06 2014

​Relative Strength Index

Hey there, Protraders!

Today we will review one of the most well-known technical indicators – “Relative strength index”. This indicator has been successfully used by traders and analytics around the world for over 35 years. It was created by J. Wallace Wilder and was originally used on the commodity futures. This indicator got widespread and currently it is almost obligatory part of any analytical platform. RSI refers to the indicators of the oscillating type, which means that the indicator is calculated on the base of the moving average and its values is changed in some corridor. As the name suggests, “Relative Strength Index” assesses the relative movement strength of the considered instrument. Indicator values are calculated by the following formulas:

Indicator values are calculated by the following formulas

where:

Down=Price [i-1]- Price[i] when Price [i-1] > Price [i];

Up= Price [i] - Price [i-1] when Price [i] > Price [i-1];

Price [i-1] – characteristical price of the previous bar;

Price [1] – characteristical close price of the current bar;

N – Smoothing period;

MA – Moving average (can be used both the simple and exponential averaging);

Price – is one of the available price characteristics (High, Low, Close…).

Thus, RSI is the ratio of rising and falling bars, adduced to the relative values, which is smoothed by a moving average over some period N. Based on the indicator description it is evident that RSI measures the relative strength of fall or rise of investigated asset.

There is an opinion that the technical indicators which are undoubtedly derives from the price, have no value for the trader. However, relying on creators' works of technical indicators, we can say that when creating them the authors were describing a specific market situation. In this case, the extreme RSI values are designed to identify the trade situations in which the majority of market participants sided with the bears or bulls. Such situations of mass traders’ belief in the growth or fall of the traded instrument often end with market reversal.

Using the Protrader 3 trading terminal, a trader is able to use the technical indicator RSI. To add the indicator to the chart of considered instrument, go to menu “Add indicator - > Index” and select RSI.

Using the Protrader 3 trading terminal, a trader is able to use the technical indicator RSI.

The indicator settings window will appear after that; let’s consider in details the available options:

The indicator settings window will appear after that; let’s consider in details the available options

User can choose the calculation period of RSI (“RSI period”) in the menu “Parameters”, classic indicator period is 14 days (in the classic version RSI was used on the daily charts). The calculation method setting is also available where user can choose one of two methods: “Simple” or “Exponential”. Indicator values are further smoothed by a moving average, type and period of this moving average is determined by the parameters “Type of Moving Average” and “Period of Moving Average”. User can choose how to display the indicator: in the additional window “Sub window” or in the main window “Main”.

 can choose how to display the indicator in the additional window Sub window or in the main window “Main”

In the settings window of the first indicator line which displays the RSI values, the following settings are available:

  • visibility/invisibility of the line (“Visible 1”);
  • color of the line (“Color 1”);
  • name of the line (“Line name 1”);
  • scale factor by the Y axis (“Y factor 1”);
  • style of the line (“Line style 1”);
  • time offset (“Time shift 1”);
  • width of the line (“Line width 1”).

the settings window

In the settings window of second indicator line which is responsible for a moving average, the settings are identical to the first-line.

In the settings window of second indicator line which is responsible for a moving average, the settings are identical to the first-line

In the settings window of second indicator line which is responsible for a moving average, the settings are identical to the first-line.

In the settings window of third and fourth indicator line which are responsible for the top and bottom extreme RSI zones, the settings are identical to the first and second line. The only difference is the ability to set the value of these lines (“Value 2” and “Value 3”).

After setting up the indicator the working chart will look like this (displaying of the indicator is selected in an additional window):

displaying of the indicator is selected in an additional window

Let’s consider the most common methods of applying the technical indicator RSI. Let’s note the outputs from the extreme zones and the subsequent price reaction. It is visible that once the indicator has reached the extreme zones, the price for some time can move by inertia, but then the reversal occurs. This RSI feature is the most common application of this indicator. Values of the indicator's extreme zones are determined by the nature of instrument motion, if values reached the upper extreme zone, then the instrument is considered to be “overbought” and the short positions are preferred; if values reached the lower extreme zone, then the instrument is considered to be “oversold” and the long positions are preferred.

The next method of RSI application is the use of price divergence and indicator’s values.

The next method of RSI application is the use of price divergence and indicator’s values.

When every local high/low of the price is not confirmed by corresponding local high/low on the indicator chart, then we say that there is a divergence and a price reversal will be followed soon. On the screen we can see how the local highs 1, 2, 3 on the price chart are accompanied by the local lows 1, 2, 3 on the RSI chart. Then the reversal of price movement was followed by.

On the screen we can see how the local highs 1, 2, 3 on the price chart are accompanied by the local lows 1, 2, 3 on the RSI chart

In the trend strategies traders use crossing signal by RSI indicator the value 50, as a confirmation of the trend change. In this case, the RSI value = 50 is interpreted as a state of rest or parity of buyers and sellers. If the RSI crosses the value of 50 from the top down then it is saying about the prevalence of sellers in the market. If the RSI crosses the value of 50 from the bottom up, then it is treated as prevalence of buyers.

In the trend strategies traders use crossing signal by RSI indicator the value 50, as a confirmation of the trend change

The RSI indicator is also used to construct zones of support/resistance and trade from them. As you can see on the screen the resistance zone was determined by points 1 and 2. Price broke the resistance at the point 3, but breakdown hasn't occurred on the RSI. After that the price decline was followed by. This pattern is called "false" breakdown.

We have reviewed the main application methods of the technical indicator RSI in trading. Of course to build a profitable trading system it is not enough to use only one RSI, but it can serve as an excellent filter for your trading systems. Of course, RSI can and should be used when automating the trading systems. Using the code below, you can get RSI values and include them into your trading system:

double iRSI(<br>
 string symbol,  // symbol name<br>
 int timeframe, // timeframe<br>
 int period, // period<br>
 int applied_price, // type of the price<br>
 int shift // offset<br>
 );

The modification of RSI indicator is also available for the users of Protrader 3 trading terminal, so called ARSI (Adaptive Relative Strength Index) which is a more flexible and smoothed variant of RSI.


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