1. A
security’s price moves
reflect changing consensus
about its worth among buy-
ers and sellers. Those col-
lective positions, over the course of a
business day, determine the securi-
ty’s closing price. And that price, in
turn, is the basis of traders’ account
settlements; it also becomes critical
information in buyers’ and sellers’
decision making on subsequent
trading days.
Closing prices therefore constitute
important information feedstock
for technical analysts. And
the relative strength index
(RSI), which measures the
strength of any trading vehi-
cle against itself by monitor-
ing changes in its closing
prices, provides important
insights for those analysts.
The relative strength in-
dex was first described by
J. Welles Wilder Jr. in his
1978 book New Concepts in Technical
Trading Systems. It can be expressed as
RSI = 100 – [100 ÷ (1 + RS)].
In that formula, relative strength
(RS) equals the average of net up
closing changes divided by the aver-
age of net down closing changes. For
example, for a 14-day RSI, you’d look
at a security’s closing prices for the
previous 14 trading days. To get the
average for net up trading days,
you’d add up the day-over-day
change in closing prices for each of
the 14 days the security closed high-
er than it did the previous day and
then divide that total by the number
of days the security closed higher. To
get the average price change on net
down trading days, you’d add the
day-over-day change in closing prices
on those days of the 14 that the secu-
rity closed lower than the previous
day’s close and then divide that total
Staying AheadWith
Day’s–End Trade Signals
Movements that
technical analysts
observe in the
relative strength
index often suggest
future market
movements
FIGURE 1. Type US1 <Cmdty> RSI D <Go> to see a graph of the relative
strength index of the generic U.S. long-bond future for the previous year.
Enter 9 in the DAY RELATIVE STRENGTH field, and press <Go>
Bloomberg May 1998 75
EQUITY
¬You can make adjustments to the
RSI reference lines by typing TDEF
<Go> <Page Fwd> and tabbing in to
the Oscillators section to change RSI
oversold and overbought levels.
Type RSI <Help> for more
information on the function
Tip Box

2. Encyclopedia of Technical Market Indica-
tors. “And the opposite also is true. If
you have a security that is less volatile,
you can shorten the RSI to generate
more buy and sell signals.” Such in-
creased volatility is caused by the
greater effect a single day’s price
change or a short-term trend can
have on relative strength when you
average over a shorter time period
(figure 1).
The Historical Price RSI screen
consists of two graphs. The upper
one is a bar graph of security or
index value over the time period
specified in the Range field. Below
that graph is the actual rel-
ative strength index dur-
ing the same time period.
The scale at the right of
the lower graph shows the level of the
RSI. The index ranges from zero to
100, with the extremes representing
regions in which the security has had
significantly more net up trading
days—the overbought region—or
significantly more net down trading
days—the oversold region.
Overbought and oversold barriers
usually are drawn at 30/70 lines.
“Although 30 and 70 were levels
Welles Wilder suggested, the over-
bought-oversold indicators can and
do change over time. [Even though]
we keep the 40-point trading range
relatively constant, bull market up-
trends shift the 14-day RSI range up
10 points, to 40 and 80, [and] bear
market downtrends push the range
down to 20 and 60,” says Andrew
Cardwell Jr., president of Cardwell Fi-
nancial Group in Woodstock, Ga.
Three of the most common trad-
ing applications that can be derived
from the RSI are divergences, chart
patterns, and overbought and over-
sold areas. Buy or sell signals from
RSI can come from bearish and bull-
ish divergences between RSI trends
and price trends. “I have found that
divergence between the RSI trend
and the underlying stock price trend
is more important than the RSI’s
breaching some arbitrary level,” says
Bill Stone, institutional salesman at
Gruntal & Co. in Pittsburgh. Those
divergences tend to occur at major
price tops or bottoms, and they show
up when a trend is weak and about
to reverse.
A
n example of a bullish
divergence would be prices
that fall to new lows at the
same time as the RSI makes
a more shallow bottom than it did
during its its most recent decline.
The activity of Intel Corp. stock
showed just such a bullish divergence
in the year ending in late March
1998. Type INTC <Equity> RSI
D <Go> to see the divergence in
trend between the two graphs. Press
<Page Fwd> for a table of RSI data
that show actual price and RSI values
in late 1997 as Intel made new price
lows while the RSI measure did not,
signaling the subsequent reversal
(figure 2).
Classical charting methods also can
be applied to the RSI line because
common price patterns often appear
within RSI charts. “You will see typi-
cal chart patterns such as wedges and
ascending and descending triangles
in the RSI line itself,” says Cardwell.
The RSI also is a leading—or coinci-
dent—indicator, never a laggard
one. With classical chart pattern
analysis, the point merits attention
because the RSI usually completes
those patterns a few days sooner,
FIGURE 2. Type INTC <Equity> RSI D <Go> for a graph of Intel Corp.’s relative
strength index during the past year. Press <Page Fwd> to compare tabular price
and RSI data
76 May 1998 Bloomberg
by the number of days the security
closed lower. Dividing the net up av-
erage by the net down average gives
the relative strength used in the
RSI calculation.
You advance your relative strength
computation daily by adding the
most recent close and dropping the
oldest. In the RSI computation, rela-
tive strength refers to the strength of
the security with respect to itself. It
differs from regular relative strength
in that it isn’t measuring the security
against a benchmark index.
To see how analysts might use the
RSI indicator in their prognostica-
tions, type US1 <Cmdty> RSI D <Go>.
The screen shows the historical price
RSI for a generic U.S. long-bond fu-
ture. Tab into the Day Relative
Strength field to change the RSI
time span. Change the time period—
which defaults to 14 days—by enter-
ing 9 in that field to see that this now
more sensitive RSI seems more errat-
ic and its trading signals more visible.
“With a more volatile security, you
can tame the volatility and reduce the
number of signals by lengthening the
RSI time period,” says Robert Colby,
coauthor with Thomas Meyers of the
The strongest RSI buy/sell signals come
from divergences between RSI and price

3. out on a 30-point rise over the next
two years” (figure 3).
Clearly, knowing how—and even
whether—to react when the RSI
reaches oversold and overbought
levels is important. When it reaches
extremes, some traders shift their
focus from a weekly to a daily RSI to
better highlight changes in trend.
Again, shorter RSI periods more
quickly identify trend changes at the
expense of generating more volatili-
ty and possibly more false signals.
Jake Bernstein, president of MBH
Commodity Advisors in Winnetka,
Ill., also defined what he termed pop
signals when the RSI crosses one of
its reference lines. “We find that
there is a higher probability of mak-
ing money if we buy when a market is
in the overbought range and sell
short when a market is oversold—
defining overbought as an RSI above
80 and oversold as a market with an
RSI below 15,” says Bernstein.
A sell signal is given when it crosses
its oversold reference line downward;
a buy signal when it crosses its over-
bought line upward. These rare sig-
nals work best with a more sensitive
RSI of, say, seven or nine closing
days. They’re useful for day trading
or even shorter-term, intraday trad-
ing and for small price moves.
“It is optimal to combine the RSI
with trend-following indicators. Trad-
ing on the first exit of oversold or
overbought areas is risky. The best
signals are given when divergence
patterns are in formation,” says Luca
Guccione, financial adviser at Pru-
dential-Bache International in Lux-
embourg. That being so, you must be
extremely nimble to use these signals
and you must have mastered basic
signal recognition well beforehand.
R
si signals—though very
helpful—are not infallible;
no systematic trading rule
should be taken for granted
and applied blindly to all trading sit-
uations. Look, for example, at the
Dow Jones industrial average. Type
INDU <Index> RSI W <Go> to plot
the past five years of weekly closing
prices of the RSI. From April 1995 to
January 1996, while the Dow steadily
rose more than a thousand points,
the RSI was regularly in the over-
bought range (figure 4).
At the end of many trading days,
the traders who apply technical analy-
sis most effectively win. Using an end-
of-day indicator like the RSI often
can make you a winner, too.
¬Any comments? Type MAGAZINE
<Msge>.Forreprints,typeMAGZ<Go>.
Jean-Marc Bloch is on the staff of the
Bloomberg Sales department in London
FIGURE 3. Type EK <Equity> RSI W <Go> to see a weekly RSI graph for
Eastman Kodak Co. for the past five years
FIGURE 4. Type INDU <Index> RSI W <Go> to see a weekly RSI graph for the
Dow Jones industrial average for the past five years
Bloomberg May 1998 79
thereby providing early hints of likely
trend changes.
Trend changes usually occur when
the RSI enters oversold or over-
bought regions. Like analyzing diver-
gences and chart patterns, applying
strict buy and sell rules when the
RSI approaches extreme highs or
lows is far from the only rule traders
need. “Look at Eastman Kodak
[Co.],” says Stone. “In the spring of
1995 it traded at an RSI level above
75. Using [only] strict 30/70 levels,
you would have sold the stock at
[about] $60 per share and missed