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What is the RSI indicator and how does it work?

RSI (Relative Strength Index) is a momentum indicator developed by J. Welles Wilder.

It oscillates between 0 and 100 and aims to measure the “speed” of price changes.

This means that the faster the price rises, the higher the RSI value (and vice versa).

This is the RSI indicator formula…

RSI = 100 – 100 / [1 + RS]

Where RS = average gain / average loss

wait!

Don’t let the math scare you, because it’s not as “scary” as it seems.

I will break it down into something that even a 10-year-old child can understand.

let’s start…

How does the RSI indicator work?

As you can see, the only “tricky” part is the RS calculation, which is defined as…

Average gain/average loss

In other words, when the average gain is large (or the average loss is small), the RSI indicator rises.

Now you may want to know:

“How does the value of average earnings rise?

simple.

When the price rises rapidly with little correction, your average gain is large because the price is gaining positive gains-this leads to a higher RSI value.

Similarly, when the price drops rapidly with little correction, your average loss is large because the price is generating negative returns-which results in a lower RSI value.

at last……

The average gain/loss can be manipulated by the RSI setting.

E.g:

  • If you choose the 14-period RSI, the average gain (and loss) will be based on the last 14 candles
  • If you choose a 5-period RSI, the average gain (and loss) will be based on the last 5 candles

Therefore, if you use a lower RSI period setting, the indicator is more sensitive to recent price changes (for higher RSI period settings, the situation is the opposite).

Reasonable?

This is the running RSI indicator (using the default 14-period RSI)…

Now you may want to know:

“What is the difference between Stochastic and RSI?”

Well, they are similar but different.

I will explain…

This Stochastic index Similar to RSI because they are both momentum oscillators.

In other words, they measure the momentum of the market, and their values ​​are between 0 and 100.

But how are they different?

Well, the calculations of Stochastic and RSI indicators are different.

However, they use the same concept to measure momentum.

Therefore, you should not be surprised to see that Stochastic and RSI point in the same direction (although the values ​​are different).

So, the bottom line is this…

If you want to use momentum indicators (such as RSI or stochastic indicators), just choose one, because they almost tell you the same thing.

continue…



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