Relative Strength Index (RSI)

This article is aimed at letting you know the definition of relative strength index (RSI. It is elaborated in the meaning of relative strength index, calculation of RSI, RSI bullish divergence, RSI bearish divergence. Also, hidden bullish and bearish divergence are all discussed here.

In recent times, there has been a lot of technical analysis. This makes it difficult to know which analysis is authentic and best. For this reason, its advisable to go back to the drawing board. Our major focus is on a very popular technical indicator called Relative Strength Index.

If you are trade inclined, you must have come across a price chart. In this chart, you will notice a wavy line above it. You must have also heard about the word Divergence. All this relate to Relative Strength Index. We shall go further to know the meaning of RSI, how it works and some examples of divergence.

Meaning Of Relative Strength Index (RSI) ?

The Relative Strength Index (RSI) is a technical indicators that evaluates an asset to dictate its strength and weakness. RSI has a vertical movement between 100 and 0. There is a narrative about the sale of an asset. It is assumed that, sales above 70 is over bought and sales under 30 is oversold. See below for image explanation.

In a situation where markets are progressing, RSI remain strong at the 40-50 region. When markets are not performing well, RSI goes below 50-60.

Calculation Of RSI

Calculation of RSI (relative strength index) isn’t difficult. It requires using the right simple formula which involves the average of bullish and bearish move in a given time. Usually, this period is 14 candles.

Let’s give an example. In a period were there are nine bullish days with an average move of 1.2%, and five bearish days with an average move of -0.7%.

Inputting this figures into the RSI formula:

RSI =100-(100/(1+Average Bullish Move Average Bearish Move))

Whatever the result gives, is the exact RSI value of the current candle. At any point a new candle arises, the average is calculated again. This also means the change in RSI value. The importance of RSI cut across regions that are overbought and oversold.

In a situation where the price gives a new high and low value and RSI does not, it mean we might see a reversal. It is a type of divergence between price and indicator. Some of the examples are:

What Is a Relative Strength Index (RSI) bullish divergence?

Whenever the RSI forms a strong resistance to the price, we say a bullish divergence has occurred. A situation where the price prints a lower low but RSI prints a higher low, it means RSI bullish divergence. This leads to a price reversal to the upside.  

There are other bullish divergence that happen just like the one above. A unique bullish divergence is a higher low on RSI and an equal low on price. Also, when there is a lower low on price and equal low on RSI.  

Meaning of Hidden Bullish Divergence?

A distinguishing factor in hidden bullish divergence is, it doesn’t signal reversal but continuation. There are certain situations where hidden Bullish divergence occur. An example is when the RSI makes a lower low and price makes a higher low. When this happen, the price remains consolidated while the RSI moves. The chart below will explain more about a hidden bullish divergence giving continuation signal. 

Meaning of RSI Bearish Divergence?

A situation where the relative strength index is weaker than the price, we say RSI bearish divergence has occurred. The simple explanation to this is, when the price hits a higher high, while RSI hits a lower high. There is always a signal for a price reversal towards the downside as this is regarded as a strong bearish divergence. See below for a chart example.

Another instance for bearish divergence is when there is a lower high on RSI but an equal high on price. If price also rings a higher high and RSI hits equal highs, it is regarded as a bearish divergence.  is when the price prints a higher high while RSI prints equal highs. At the end of this article, we will review a cheat sheet to understand these divergences.  

What Is a Hidden Bearish Divergence?

The bearish divergence possess a hidden variant, similar to the bullish divergence. Both of them are synonymous in the sense that, the both call continuation signals rather than reversal signals.

A perfect example of a hidden bearish divergence is when the RSI makes a higher high, and the price makes a lower high. When this happens, the RSI doesn’t progress. It falls while price remain weak.

 It is now obvious that bearish divergence happen on the highs both in price and in relative strength index.

​​Divergence Cheat Sheet

This divergence cheat sheet aims at enabling you visualize the examples stated above. It does this by revealing the strong, the medium and weak divergence.  See the chart below.

CONCLUSION

Personally, I prefer to merge divergences with support and resistance. You are urged to enter a short trade if you notice a bearish divergence moving up into a resistance. The much we have discussed a the basics to RSI. If you wish, you can further your study on RSI to get more knowledge.  just a few simple ways to get started with the relative strength index. There are more complex ways of analyzing charts since you can take RSI as far as you want.

Related Content

Leave a Comment