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How to Gauge your Profit and Loss Using the RSI Indicator?

  • July 2014
  • Posted By Ninoslav

RSI stands for Relative Strength Index. It is categorized as a momentum oscillator that measures velocity and magnitudes of directional price movements. It is the ratio of average profit to average loss, taken over a time period. This RSI indicator is also known as Wilder’s RSI.

How it works?
It oscillates between zero and 100. However, conventionally it is taken to be overbought when RSI is about 70 and is considered to be oversold when it falls below 30. To calculate the RSI, average gain and average loss are calculated over a period of 14 days.

First Average Gain= total gains over past 14 days/ 14.
First Average Loss=total losses over past 14 days/ 14.

Subsequent average gains and losses are calculated based on the prior average gains and losses.

Since it is an exponential average, RSI calculation becomes more precise as calculation period extends. Although the default range is taken to be 14 days, but it can be reduced to increase sensitivity and increased to reduce sensitivity. Changing some parameters, like raising the upper bar from 70 to 80 and lowering the lower bar from 30 to 20, reduces the number of overbought/oversold readings. Short term traders use two-period RSI.

Versatile momentum oscillator:
RSI indicator has remained a versatile momentum oscillator over a great period of time. Reversal is opposite of divergence. Overbought conditions are considered to be a great time for the reversal and overbought is a sign of strength. The stock’s recent trading strength is measured by the level of RSI. The divergence between the price action and RSI indicates a market turning point.

However, a new RSI called Cutler’s RSI is based upon the simple moving average of U and D. Cutler’s RSI is a bit different from the normal Wilder’s RSI.


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