Description: The Relative Strength Index is one of the most common indicators in use today. It is difficult to find a chartist that doesn't have RSI pasted to the bottom of his or her chart. It was developed in 1978 in order to resolve two specific problems with momentum indicators of the time. The first problem was that momentum lines often became erratic due to sharp changes being dropped out of the calculation as time passed. For example if we were constructing a 14 day momentum line, and there was a sharp decline 14 days ago, then that value would contribute a significant sum to our momentum calculation, until the 15th day after it, when it would suddenly and completely disappear from the calculations. This would then cause the momentum value to rise sharply on the 15th day after the sharp decline. There was an obvious need to smooth the momentum. The other problem was that there was a need to get the indicator to display a consistent range so that different instruments and timeframes could be compared.

The Relative Strength Index solved both problems brilliantly, by providing the necessary smoothing AND by limiting its range to oscillations between 0 and 100 (hence the name "oscillators" for all such indicators). We can see in the Calculation section below how this is accomplished mathematically.

Uses: The Relative Strength Index is a measure of how oversold or how overbought a financial instrument is. RSI values below 30 indicate and oversold condition, while RSI values above 70 indicate overbought. The most basic use of RSI relies on these trade signals - once RSI is overbought, and curls downward towards breaking out of the overbought territory it's time to short the pair, and vica versa with the oversold condition.

Another popular use is to determine bullish or bearish divergence. For example, if the currency is making a new high, while the RSI is not, this is an indication that the up trend may be ending soon (bearish divergence). The signal usually comes when the RSI line drops below its most recent trough.

There are a wide range of other uses for the Relative Strength Index indicator.

Most Common Settings: The most common period is N=14. Other popular settings are N=9, 7, and 5 which work to increase the volatility of the RSI chart. Some technical analysts use longer periods like N=21 or 28 in order to smooth the RSI curve in hopes of achieving more reliable signals. Some trading platforms also allow you to set the bounds as parameters, so if you would like RSI to move between 0 and 200 instead of 0 and 100, you can change it. This can be marginally useful when running comparisons with other indicators. It is also possible to apply additional smoothing to the RSI indicator, which is beyond the scope of this article.

Strengths: The RSI has the advantage of being a very elegant indicator, in that it's movements are smooth, and it can fit into a neat package between 0 and 1. It has the added advantage of being used by many traders out there, which is not only a testament to its abilities, but it also makes its signals self-fulfilling at times.

Weaknesses: Doesn't take into account how many up days vs. down days there are in the range, so one single big decline could offset a large number of gain periods and vica versa. The RSI is also notoriously weak in strongly trending markets because it can remain oversold/overbought for a long time during strong trends. Avoid using RSI in strongly trending markets.