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The RSI is a momentum-derived oscillator that is very popular among futures traders, and some stock traders. Typically oscillators based on momentum or price differences will have a problem when there are erratic and sharp price movements within the time period under consideration. When a big advance or decline is finally dropped from the time period used by the momentum oscillator, it will cause the oscillator to show a movement even if in actuality there is little price movement. |
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Suppose you are using a simple 10-period rate-of-change (ROC) indicator and 10 days ago there was a huge move (up or down). However, yesterday and today the price barely changed. Consequently the ROC indicator will barely change today from yesterday. Now let us go forward one day, and once again the price barely changes. You would think that the oscillator would also change just a little. In reality the oscillator will change a lot, since the huge move made (now) 11 days ago has been dropped from the mathematical calculation. |
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The RSI will dampen or smooth out these distortions. In addition, a typical momentum indicator is not contained within a predefined vertical range. Hence you must constantly refer to past history when comparing past highs or lows, in order to determine oversold or overbought conditions. Again the RSI solves this problem, since the indicator is contained within a vertical range of 0 to 100. |
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Many books on technical analysis use a 9- or 14-period look-back to perform the RSI calculations. The longer the time period, the less sensitive the oscillator becomes, and the smaller its amplitude. I like the RSI with a time period of 14, because it works best for me and, as strange as it may sound, is half the lunar cycle. The rest of this discussion on RSI levels will use the 14-period look-back, regardless of whether we are looking at hourly charts or monthly charts. I use the 14-period look-back on all markets over all time periods, including the 5-minute bar chart. In order to gain more sensitivity, some traders will use the shorter 9-period look-back. |
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For the RSI formula to give valid results, you want to have at least 90 days (or periods) of data. Should you have fewer than 90 periods, the results given by the RSI formula will not be accurate for trend analysis. I prefer to have at least 200 periods of data when looking at any chart. In other words, if I am trading off of a 5-minute chart (each bar represents 5 minutes), I want to have at least 200 bars or 1000 minutes of data. |
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Books on technical analysis typically state that any movement above 70 on the RSI is overbought, while any movement under 30 is oversold. An important fact to remember is that any oscillator (the RSI included) in a strongly trending market will become either oversold in a bear market or |
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