Relative Strength Index (RSI)

The Relative Strength Index (RSI) is computed by comparing the strength of the markets’ upward closes to that of the downward closes. The calculation begins by defining every day if the close was higher or lower than the previous day. If the close was higher we define

U_(p) = Close_today – Close_yesterday
D_(own) = 0

If today’s close was lower than the previous day we define

U = 0
D = Close_yesterday – Close_today

In case both days had the same closing price we can define both U and D as zero.
With these numbers we can calculate the Relative Strength (RS) by taking the Exponential Moving Average (EMA) with N-days smoothing factor (27 is recommended):

RS = (EMA[N] of U) / (EMA[N] of D)

The Relative Strength Index can then be computed out of the RS

RSI = 100 – 100 x 1/(1+RS)

The Relative Strength Index can be used to spot oversold and overbought situations. Oversold is often being defined as when the RSI falls below the 20 level, while a rise above 80 is considered overbought. Traders have to be careful when watching these numbers. Strong fundamentals can justify a level above 80 or below 20, and a break of those levels should therefore not automatically be considered as a buy or sell signal. When used in complement to other technical indicators the RSI can be very useful, but you should not rely solely on this indicator.