The Relative Strength Index is an exceptional technical indicator. A complete grasp of how this Strength Index is calculated will help you deep understand technical analysis.
Since the RSI is such a critical trading accessory, understanding how it’s calculated keeps you at an advantage. This guide is a carefully compiled detailed solution on rightly calculating the relative Strength Index(RSI).
We would also discuss how the calculations are incorporated into the RSI Excel calculator.
Simple RSI Formulas
There are majorly three calculation methods for the AvgU and the AvgD, and it’s all explained in this guide.
For the calculation of the Relative Strength Index, there are four significant steps which include:
- Calculate the moves Up and the moves Down (also known as the U and D)
- Take an average of moves up and the moves down(AvgU and AvgD)
- Relative Strength of the movements calculation (RS)
- Relative Strength Index calculation (RSI)
If RSI trading strategies interest you, then this article is a perfect read for you. I would carefully work you through the procedure involved in calculating the Relative Strength Index (RSI).
These formulas work perfectly in Excel, and you can use the RSI Excel calculator. All the procedures for arriving at a solid solution would be well explained in this guide.
Step 1: Calculate the moves Up and the moves Down
For simplicity, we’d focus on how you can calculate RSI for the standard periods like 14 and 20.
Calculations for RSI 14 period require the daily closing price for the last 15 days. Conversely, period 20 requires a daily closing price for the previous 21 days.
Firstly, we need to calculate the past 14 days’ up and down moves.
Each bar-to-bar change for each bar is calculated with: Chng = Closet – Closet -1
For every bar with up moves (U), we use the formula:
Closet – Closet-1 if a change in price is positive
Zero if a difference in price is negative or zero
Bar with Down moves equals.
The absolute value of the closet-Closet-1 if the price variation is negative.
Zero if the difference in price is positive or zero
Step 2: Take an average of moves up and the moves down(AvgU and AvgD)
You can use three unique methods for calculating the price average. Each of these methods is different from the other, but all present an accurate way for taking price average:
Simple Moving Average
This is a very straightforward calculation technique, AvgU and AvgD are like a simple moving average:
Exponential Moving Average
The AvgU and AvgD of the EMA are calculated from bullish and bearish moves with the help of the exponential moving average formula. The EMA formula of the AvgU and AvgD is similar to the EMA of price movement.
The EMA period is the same as the RSI period, and here is the formula:
Wilder’s Smoothing Method
J. Welles Wilder, who invented the RSI, had a reliable smoothing method used in calculating the indicator.
His method uses very similar logic like the exponential moving average,
But there is a difference in their smoothing factor, which we can calculate using the following method:
α = 1 / N
and therefore 1 – α = ( N – 1 ) / N
N = RSI period
Here is an example: For an RSI 14, the formula for the average up move is:
AvgUt = 1/14 * Ut + 13/14 * AvgUt-1
Interestingly, the logic of these calculations is very similar to the
the measure of Average True Range (ATR) is another indicator invented by J. Welles Wilder.
Step 3: Calculate the Relative Strength of the moves (get RS)
After arriving at a reasonable solution, we take the average bullish move as price rises (AvgU) and the average bearish move as price falls (AvgD) in the previous 14 price bars. We then calculate Relative Strength, which is the ratio of average bullish moves and average bearish moves.
RS = AvgU / AvgD
Step 4: Calculate the Relative Strength Index (RSI)
Relative Strength Index (RSI)
Since we know the Relative Strength and we can write the RSI formula:
RSI = 100 – 100 / ( 1 + RS)
RSI Oversold Lowest Value
An absolute bearish market would produce the lowest possible RSI
value. Every trading day where the market value closed lower than the previous day, there’s absolutely no bullish day, and every U’s and N bar would have to take a value of zero.
AvgU also takes a value of zero. The SMA method, which comes after N bars, EMA, and Wilder’s methods, would gradually approach zero with every bar, especially if there are non-zero U’s before.
Consequently, the average down (AvgD), assumes a positive number when using the absolute values while calculating the RSI. Relative Strength will have to take only positive zero-sum divided by only positive, which produces a final value of zero. The RSI, in this case, would be zero:
RSI = 100 – 100 / ( 1 + 0 ) = 100 – 100 = 0
RSI Overbought Highest Value
A bullish market run is a perfect situation that would give us the maximum possible RSI value.
AvgD value approaches zero, and the AvgU alternative takes a positive number. Relative Strength can be assumed as a positive number but has no defined mathematical calculation, but we can represent the RSI’s value as 100.
The RSI’s value can be up to 100 if the market’s relative strength is zero and the average falls to a meager number but not zero.
RSI = 100 – 100 / ( 1 + a big number ) = 100 – 0 = 100
RSI’s value approaches zero in an up-trending market and can also get to 100 in a falling bearish market.
RSI reading and interpretation
The three calculation methods provide different results. And traders can pick amongst the three according to their preferred trading style and how they look at the market per time.
Understanding and perfecting a method is a better convenient RSI usage approach than swapping out techniques.
The RSI Calculator makes it possible to throw in 3 different RSI indicators on the chart all at once. As a result, it’s possible to use different RSI settings in the same market structure. But it’s only advisable to stick with one RSI setup while trading.
The RSI is the ideal technical indicator for identifying overbought and oversold conditions. By checking the RSI line, we can find short-term but also long-term buy and sell signals.
We can do RSI reading in conjunction with price action in forex trading, but it is handy, especially in the stock market. A stock will sell, and with the RSI below the 30 levels, we have an RSI signal to buy.
One of the most used strategies is the 2-period RSI on the US stock market index S&P500, which reacts well to buy signals below the 10 level.
Using the RSI on a time frame daily is certainly preferable as there is too much noise in the intraday phases, and this indicator is not reliable.
Now that you have learned how to calculate the RSI, you can create variations, such as the smoothed RSI, or use your favorite moving average. For example, you can replace a simple moving average with a Hull Moving Average and invent your own RSI Indicator.