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The RSI is presented in a graph below the price chart of a market. It is usually plotted as
lines along with two moving averages connecting the relevant values for each period.
Wilder recommended a smoothing period of 14. This is by his reckoning of EMA
smoothing, i.e. α=1/14 or N=27.
Wilder posited that when price moves up very rapidly, at some point it is considered
overbought. Likewise, when price falls very rapidly, at some point it is considered
oversold. In either case, Wilder felt a reaction or reversal is imminent. The slope of the
RSI is directly proportional to the velocity of the move. The distance traveled by the RSI
is proportional to the magnitude of the move.
As a result, Wilder believed that tops and bottoms are indicated when RSI goes above 70
or drops below 30. Traditionally, RSI readings greater than the 70 level are considered to
be in overbought territory, and RSI readings lower than the 30 level are considered to be
in oversold territory. In between the 30 and 70 level is considered neutral.
Wilder further believed that divergence between RSI and price action is a very strong
indication that a market turning point is imminent. Bearish divergence occurs when price
makes a new high but the RSI makes a lower high, thus failing to confirm. Bullish
divergence occurs when price makes a new low but RSI makes a higher low.
Wilder thought that "failure swings" above 70 and below 30 on the RSI are strong
indications of market reversals. For example, assume the RSI hits 76, pulls back to 72,
then rises to 77. If it falls below 72, Wilder would consider this a "failure swing" above
70.
Finally, Wilder wrote that chart formations and areas of support and resistance could
sometimes be more easily seen on the RSI chart as opposed to the price chart. The center
line for the relative strength index is 50, which is often seen as both the support and
resistance line for the indicator.

If the relative strength index is below 50, it generally means that the stock's losses are
greater than the gains. When the relative strength index is above 50, it generally means
that the gains are greater than the losses.

In addition to Wilder's original theories of RSI interpretation, Andrew Cardwell has

developed several new interpretations of RSI to help determine and confirm trend. First,
Cardwell noticed that uptrends generally traded between RSI 40 and 80, while
downtrends usually traded between RSI 60 and 20. Cardwell observed when securities
change from uptrend to downtrend and vice versa, the RSI will undergo a "range shift."
RSI Indicator Divergence
Example of RSI Indicator Divergence
Next, Cardwell noted that bearish divergence: 1) only occurs in uptrends, and 2) mostly
only leads to a brief correction instead of a reversal in trend. Therefore bearish
divergence is a sign confirming an uptrend. Similarly, bullish divergence is a sign
confirming a downtrend.
Finally, Cardwell discovered the existence of positive and negative reversals in the RSI.
Reversals are the opposite of divergence. For example, a positive reversal occurs when an
uptrend price correction results in a higher low compared to the last price correction,
while RSI results in a lower low compared to the prior correction. A negative reversal
happens when a downtrend rally results in a lower high compared to the last downtrend
rally, but RSI makes a higher high compared to the prior rally.
In other words, despite stronger momentum as seen by the higher high or lower low in
the RSI, price could not make a higher high or lower low. This is evidence the main trend
is about to resume. Cardwell noted that positive reversals only happen in uptrends while
negative reversals only occur in downtrends, and therefore their existence confirms the
trend.
Cutler's RSI
A variation called Cutler's RSI is based on a simple moving average of U and D,[2]
instead of the exponential average above. Cutler had found that since Wilder used an
exponential moving average to calculate RSI, the value of Wilder's RSI depended upon
where in the data file his calculations started. Cutler termed this Data Length
Dependency. Cutler's RSI is not data length dependent, and returns consistent results
regardless of the length of, or the starting point within a data file.

RS = { SMA[N] \; of \; U \over SMA[N] \; of \; D }

This is like the initial data point calculation shown above, but used on every day, not just
the first. The divisor N in the SMAs in the numerator and denominator cancel out, so one
needn't do those divisions, instead just a sum of U and a sum of D over the past N days
can be made.
Cutler's RSI generally comes out slightly different from the normal Wilder RSI, but the
two are similar, since SMA and EMA are similar.

The Relative Strength Index (RSI) compares the strength of a stock's recent gains to the
weakness of its recent losses and turns that information into a number that ranges from 0
to 100. The Relative Strength Index compares upward movements in closing price to
downward movements over a selected period. This could be used for short cycles and for
21 or 25 days for the intermediate cycle. Relative Strength Index is smoother than the
Momentum or Rate of Change oscillators and is not as susceptible to distortion from
unusually high or low prices at the start of the window. It is also formulated to fluctuate
between 0 and 100, enabling fixed Overbought and Oversold levels. The term "Relative
Strength Index" appears to be slightly misleading as the RSI only figures out the internal
strength of a single security, but does not compare the strength of two securities on any
such parameters discussed.

The Relative Strength Index (RSI) is a financial technical analysis oscillator showing
price strength by comparing upward and downward close-to-close movements. The RSI
is popular because it is relatively easy to interpret. It is calculated using the following
formula:
RSI= 100-100/1+RS.
RS= Average of x day’s up closes/ Average of x day’s down closes.
An asset or stock is deemed to be overbought once the RSI approaches the 70 level,
meaning that it may be getting overvalued and is a good candidate for testing fresh
resistance levels. Conversely, if the RSI approaches 30, it is an indication that the asset/
stock may be getting oversold and therefore likely to become undervalued.

The theory of RSI was developed by J. Welles Wilder and published in “

Commodities”magazine (now called “Futures” magazine) in June 1978, and in his “New
Concepts in Technical Trading Systems” the same year.
J. Welles Wilder is best known for his technical indicators – now considered to be core
indicators in technical analysis software. These include Average True Range, the Relative
Strength Index, Directional Movement and the Parabolic Stop and Reverse. He has
written many articles on trading and conducted technical trading seminars in Asia,
Australia, Canada, USA, and Europe.
In the charts given above, the lower chart suggests the level of RSI in the stock, and in
this case, the stock has become oversold and ripe for purchase around the month of
March. Later on, the stock has also reached a high level exceeding 70 for RSI in
November, and gives the first signal of exit. One of the main advantages of following
relative strength index theory in financial markets on charts is that is gives an early
indication of overbought levels and oversold levels, when the RSI nears 70 and 30
respectively. Those allow the traders to make an early exit and entry into the stock/
inidces or commodities in the financial market.

References
1. Relative Strength, Comparative at MarketScreen.com
2. Cutler's RSI page at Aspen Graphics Technical Analysis Software
3. New Concepts in Technical Trading Systems by J. Welles Wilder,