RSI Divergence

The RSI Divergence is another popular indicator that can be used to identify bullish and bearish modifications in the market by observing the movements of the RSI line when it crossed over or lower the centre line.

The crossover levels can provide evidence and help traders in their methods and decisions. Divergence is where two signals are trending the opposite direction. The RSI signal can show that a price reversal may take place. See the figure below for a visual explanation.

To play, press and hold the enter key. To stop, release the enter key.

To play, press and hold the enter key. To stop, release the enter key.

The Relative Strength Index is defined as a technical analysis indicator that determines the speed and change of price movements. The value of RSI oscillates between 0-100 and the formula to calculate it is as follows.

RSI=100- (100/1+RS)

RS= Average Gain/Average Loss

According to Wilder (1978), when the RSI is above 70 it is considered overbought and when it is below 30 it is considered oversold.

What is Relative Stranrth Index

How does it work?

Let’s simplify the RSI formula and make it clearer. The basic components are: RS, Average Gain and Average Loss and the calculation of RSI is based on 14 periods. Losses are articulated as positive values and not negative values.

The first calculations are Average Gain and Average Loss

First Average Gain = Sum of Gains over the past 14 periods/14
First Average Loss = Sum of Losses over the past 14 periods/14

The following calculations are based on the previous averages and the current gain loss:

Average Gain = [(previous Average Gain) x 13 + Current Gain]/14
Average Loss = [(previous Average Loss) x 13 + Current Loss]/14

When using the first value plus the current value, it creates a more accurate RSI value as the calculation is for a longer period. The RS in Wilder’s formula stabilizes and becomes an oscillator that swings between 0 and 100. Actually an RS scheme looks exactly the same as an RSI scheme. By stabilizing, it makes it easier to recognize extremes because RSI is range bound. The value of RSI is 0 when the Average Gain is 0, and the RSI is 100 when the Average Loss is zero.

There are two basic methods of determining buy/sell signals using the RSI indicator.

RSI Crossover Levels
RSI Divergence

RSI Crossover Level

The RSI indicator can be used to determine the overbought and oversold signals when the signal increases or declines below the predefined levels. These overbought and oversold levels are referred to as Crossover Levels and their characteristic settings include 70/30 and 80/20.

Additionally, oversold signals signify that a price upturn may be occurring soon overbought signals indicate that a down-turn in price may be around the corner (approaches). See the figure below for a visual explanation.