On certain occasions euphoria or fear seize even the most experienced investors, for a moment they forget the reason and let themselves be moved only and only by the heart. If we see that a value we have in the portfolio decreases 5% -10% -15% in a single session, we will always have the sale in mind because somehow we believe it will continue to fall. In this kind of situation, technical analysis based on volume and historical price evolution can be of great help to us. Specifically, in this article, we will deal with one of the most used tools of technical analysis, the Relative Strength Index ( RSI ).
RSI Index: Relative Strength Index
The RSI, relative strength index (translated to Portuguese), is an oscillator-type indicator that measures the buying or selling strength (measured by upward and downward price changes) that takes a value during a given period. This interpretation tool was developed by J. Welles Wilder at the end of the 70s.
The calculation used to find the RSI is the following:
Be RS (relative strength) the ratio of the average of climbs to the average of descents.
The average of increases is calculated as the exponential average of the differences between the closing price of session N and session N-1 (previous session).
The average of decreases is calculated as the exponential average of the differences between the closing price of session N-1 and session N (the subsequent session), to avoid negative numbers.
In this way, the RSI is delimited by the values 0 and 100. Normally, the number of sessions used for its calculation is 14, although it may vary depending on our preferences.
Practical example with the RSI
Normally, an RSI above 70 indicates overbought and under 30 oversold, although it may change the reference values. Technically speaking, the closer the values of 0 or 100 are to the dimension values, the greater the probabilities of getting it right and the lower the chances we will have of operating.
The previous chart is an example of the DAX 30 index and if we had followed the instructions of the RSI oscillator (buy below 30 and sell above 70), we would have obtained a certain profitability in our operation.
The RSI is an indicator that takes advantage of moments of euphoria and fear, when people buy or sell without a rational cause and after a while the value tends to correct itself. It usually works best in volatile values and in periods of time that are around 14 days (usually does not work for the long term).
Nowadays, there are professional traders who have their orders scheduled to buy or sell based on variables like RSI due to the ease of programming.
As a last point, it should be said that the RSI is not a perfect indicator and there are times when it fails, so we should take more factors into consideration when trading.