How to Use the RSI and Previewing the Week for Gold – VLOG 4
Commonly known as the RSI it’s perhaps the most widespread indicator when it comes to analysing if markets are overbought or oversold.
This week’s vlog sees David discussing in depth one of the most popular indicators – the Relative Strength Index. Commonly known as the RSI it’s perhaps the most widespread indicator when it comes to analysing if markets are overbought or oversold. David picks gold as his focus for the coming week which is packed with inflation data from the UK and the U.S., as well as the first quarterly reports from earnings season.
The Relative Strength Index is a common and useful technical indicator that shows how much the price moves in the direction of its movement; transforms the price into a percentage, thereby indicating places to buy (below 30%) and sell (above 70%).
The name of this indicator, Relative Strength Index, is a bit unfortunate, since this indicator has little in common with many other indicators that measure the relative strength of a move. Typically, relative strength indicators operate on multiple prices in order to reveal the strength of a particular stock relative to another stock or index. But in this case, the relative strength index uses only the past data of the analyzed instrument, i.e. shows the power of change in relation to oneself.
To calculate the relative strength index, all you need is price data and a single parameter that determines how much historical price data will be used in the calculation. Naturally, the more data is used, the more averaged (and reliable?) Indicator. The inventor of the Relative Strength Index, Welles Wilder, chose to use 14 periods in calculating the Relative Strength Index. But you can use any number based on the timeline, the expected duration of the forecast, the period of the analyzed data, personal preferences, etc.
To calculate the relative strength index, it is necessary to distinguish between the periods (days, weeks, etc.) of the closing, which brought profit from those periods in which the price decreased in relation to the previous period. Those. before starting our analysis, we need to observe the closing prices of all n previous periods (where n is an indicator parameter). If you adhere to the recommendations, then we will analyze 14 past prices and divide them into 2 groups (rise and fall). Then we calculate 2 arithmetic means (rise and fall), and thus we will lay the foundation for calculating the relative strength index. (IMPORTANT: falls are measured in positive numbers.)
Calculating the average rise and fall over the last n periods is critical to calculating the relative strength index. I would like to draw your attention to the fact that having certain data about the price, the indicator can be calculated only starting from the n + 1-th period, since all previous periods will be used to calculate the average rise (fall) for the first value of the relative strength index.
So, when we can calculate the average rise and fall for the first period, we begin to calculate the overall average rise and fall. The total average growth (decline) for each period is the sum of the current growth (decline) and the total average growth (decline) for the previous period, multiplied by n-1, divided by n.
Further, for each period, we divide the total average growth by the total average fall, and we get the relative strength. Adding 1 to it, placing this sum in the denominator of the fraction with the numerator at 100, and subtracting the resulting fraction from 100, we get the index of relative strength for the current period.