Measuring Internal Strength: Wilder's RSI Indicator
by Wayne A. Thorp, CFA
In his 1978 book, “New Concepts in Technical Trading Systems,” J. Welles Wilder (Trade Research) introduced the relative strength index (RSI). This indicator, which has gone on to become one of the most widely used technical indicators, is a momentum indicator that belongs to a family of indicators called oscillators. An oscillator gets its name from the fact that it moves or oscillates between two fixed values based on the price movement of a security or index.
Wilder’s RSI should not be confused with relative strength figures that appear in publications such as the Investor’s Business Daily and AAII’s Stock Investor program. Those relative strength calculations compare the price movement of a security or index against the price movement of some broad market measure such as the S&P 500. In other words, they show how well a particular index or security has done relative to the broader market. Perhaps a better name for the Wilder RSI would be the internal strength index—the RSI compares the price relative to itself.
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The RSI has been found to have the most favorable results when used in the futures and commodities markets. Furthermore, the RSI is most used over a short trading period—both of which make the RSI best-suited for active trading or short-term investors. However, it is also used with equities, mutual funds, and indexes. The reason for its popularity lies in its versatility, mainly in identifying market extremes and illustrating points of divergence that may indicate an approaching reversal of the price trend. Furthermore, research indicates that for shorter periods, RSIs are leading indicators, meaning that they signal price tops and bottoms before they actually occur.
This article focuses on two of the more popular uses of the RSIs—identifying market extremes and divergences.
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