The Relative Strength Index (RSI) has been used by technical investors since its advent in the late 1970s. Technical investing is the utilization of data, price swings and momentum indicators such as RSI to determine appropriate times to buy and sell securities. RSI is a tool to help investors track average stock price highs and lows over a pre-determined time frame -- often 14 days -- and then use that information to plot opportunities for the stock to either break out, or rise above its threshold, or drop through its resistance level -- its price bottom.
Tracking Stocks Using RSI
Choose the time frame to implement the RSI calculation. When J. Welles Wilder first introduced the concept of RSI in 1978, his suggestion was to use a 14-day time frame for calculating RSI. Day traders and others have adapted this number to include seven to nine-day short-term figures, as well as 20- to 25-day cycles. The shorter the time frame chosen, the more volatile the RSI will be. This is great for day traders, but longer-term investors may be better served using 14- to 20-day cycles.
Track the price movement of the selected stock's highs and lows each day of the pre-determined time frame. For example, if a stock was trading at $10 per share, and closed on successive days at $10.50, $11 and then $10.50, there are two days of $0.50 gains and one day of $0.50 loss for the three days tracked for RSI purposes.
Taking the figures determined above, add all the stock price increases and all the price decreases for the cycle period selected. Now, divide each of the totals by the number of days to arrive at an average price gain, and an average price loss. For example, if a 14-day time frame was chosen, and the stock increased on seven of those days by a total of $14, and decreased five of those days by a total of $7, this part of the calculation requires the total gains ($14) be divided by 14, the number of days chosen, and total losses divided by 14 to arrive at the average gain and loss figures. In this case, average daily gain is $1, and average daily loss is $0.50.
With the average price gains and average price losses now determined, the remainder of the calculation is as follows: divide the average gain by the average loss, which equals 2 in the example above, and add 1 to the result, which yields 3 in this example. Now, divide 100 by this number, which equates to 33.33. The final step is to then subtract 33.33 from 100, to arrive at an RSI of 66.67.
Continue updating and tracking each day, using rolling figures. So, on the 15th day of tracking RSI using a 14-day cycle, the first day used will "fall off" the index calculation to make way for the most recent day. According to Wilder, an RSI over 70 is considered an overbought stock, and under 30 is considered oversold.