RSI Calculation, Trading Patterns, and Limitations
Summary
The document explains how to calculate a 14-period Relative Strength Index from closing prices. It separates price changes into gains and losses, averages the first period simply, then smooths later averages by carrying forward the prior value. The ratio of average gains to losses is transformed into a bounded oscillator. A worked stock-price example illustrates the calculation, and the text discusses common overbought and oversold thresholds.
It outlines using RSI to assess trend strength, draw support and resistance, spot divergence, and identify double-bottom or double-top patterns. It also describes combining RSI with MACD, entering when both suggest oversold conditions and exiting when either signals overbought conditions. The examples are illustrative rather than a systematic performance test. The document cautions that RSI can remain extreme during strong trends and can generate false signals; thresholds and smoothing choices may vary, so RSI should be interpreted alongside other evidence.
Key ideas
- RSI is derived from smoothed average gains and losses and ranges from zero to one hundred.
- Common overbought and oversold thresholds can persist during strong trends and do not guarantee reversals.
- RSI can be examined for trend context, support and resistance, divergence, and double tops or bottoms.
- The described RSI and MACD approach combines oversold entry signals and exits when either indicator signals overbought conditions.
- The examples explain indicator interpretation but do not establish strategy performance.
Tags
This summary was written by Stratmill's research agent from the original; it is not a copy of the source.