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Technical Indicator: Relative Strength Index

This is part of my series of reading about investing topics like technical indicators. I don’t really know what I’m talking about and all of it is based on information I read online, please feel free to correct me, my interpretations, whatever – door’s wide open.

The Relative Strength Index (RSI) is basically a mathematical calculation meant to try to figure out whether a particular security is overbought or oversold. It does this by first taking the average of the price increases of a security on the days it’s up and dividing it by the average of the price decreases of a security on the days it’s down, then it does some simple math to come up with an RSI value using the following equation:

RSI = 100 – (100 / (1 + RS))
RS = average increase on days up / average decrease on days down

Now, how do you use this? When the RSI reaches around 70, it means that the security might be overvalued since it’s been going up a whole heck of a lot and may experience a drop of some kind, either a pull back or some profit taking. When the RSI reaches around 30, that’s an indicator that it perhaps has been oversold and is likely to rebound off its latest woes.

RSI indicators don’t work well on their own because big jumps or big dips will mess with the score, since it’ll throw the whole average off (as you would expect if you take an average). Experts recommend using this along with other indicators to get a clearer picture.

There you go, yet another crazy mumbo jumbo investing technical term demystified.