Elephants are eaten in slices! This means that under the series "Key Concepts" we repeatedly take up the basics in order to conquer the broad field of indicators and strategies step by step.
In the "Key Concepts" section, we explain basic trading concepts that are necessary, above all, for understanding our strategy articles. The aim is to introduce beginners to complex strategies and at the same time give advanced traders the opportunity to refresh their basic knowledge.
A stock has relative strength if it generates better returns than a benchmark index over a certain period of time. Relative strength can be determined by ranking different stocks, by using indicators or by visually comparing the charts of the stock with those of the benchmark index. Many traders include the concept of relative strength (analogous to relative weakness for the short side) in order to derive long and short signals.
Relative Strength Index (RSI)
The Relative Strength Index (RSI) was conceived by Welles Wilder jr. and presented in his 1978 book "New Concepts in Technical Trading Systems". The RSI is calculated according to the formula:
RSI = 100 - (100 / (1 + RS))
With the RSI, the extent of price losses can be compared with the price gains of the same period (Pict. 1).
Bild 1: Relative-Strength-Index
Picture 1: Prices above the 70 mark are considered oversold at the RSI and oversold below the 30 mark.
In the formula RS (relative strength) stands for the quotient of the average of the closing prices of x days/weeks with rising prices and the average of the closing prices of x days/weeks with falling prices. Usually 14 days or weeks are used as the value for x. To determine the mean value of days/weeks with a positive price trend, the total price gains that have accrued within the 14 days/weeks on days/weeks with rising prices 81 must be added and divided by 14. To calculate the average value of days/weeks with a negative price trend, the total price losses incurred during this period on days/weeks with falling prices must be added up and divided by 14. Relative strength is then calculated by dividing the average price gain by the average price loss. The RS is then inserted into the RSI formula.
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