[?] Subscribe To This Site

Relative Strength Index, CommoditiesTrading Tool

The Relative Strength Index (RSI) is a momentum technical indicator, developed by Welles Wilder, used in commodity trading.

As with most indicators, the RSI works along with other performance measurements to help improve the interpretation of the price action of a traded commodity or ETF fund, for example.

How does this indicator achieve this outcome?

Get your FREE INO Trading Alerts when you subscribe to our free Commodity Universe Newsletter here. Just complete the simple form below. It's as easy as 1-2-3!

The Relative Strength Indicator helps to tackle two weaknesses in understanding momentum.

These are the need for a constant, steady band used to compare price movements, and the means of smoothing the up and down of price movement.

As an example, if there was a volatile, sharp up or down move say a week ago (in a 7 day momentum line, for example) this can cause big shifts in the momentum line even if today’s prices are relatively steady.

This can lead to giving a false signal on the price action. It may be that different commodities could have different levels for being “oversold” or “overbought”.

So how do you make sense of the data?

This is where the RSI comes in, helping to iron out the excess movement, creating a steady constant range from 0 to 100.

What is the RSI formula?

RSI = 100 – [100/(1+RS)]

Where RS = average of the days which close higher divided by those days closing lower over the time interval.

Imagine a graph where the vertical scale is from 0 to 100.

As a rule the commodity would be considered at overbought levels around 70% and conversely at oversold levels around the 30% mark.

So, for example, if the price action goes below 30%, it is fair to say the commodity in question is oversold.

Looking back to the summer of 2008, many commentators would probably concur, for example, that crude oil at around $147 was in the overbought zone, and that having fallen to around $90 it had reached oversold levels.

The norm is to use a 14-day interval for RSI but you may find it helpful to experiment with different intervals.

A commodity trader will look for clear signals that a bearish (falling) or bullish (rising) trend is occurring using this trading technique.

Other trading tools and techniques to compliment use of the RSI are support and resistance, Japanese candlesticks, the moving average, and Fibonacci levels.

The key point to remember in commodity trading is to use the relative strength index as a guide along with other measures when following the price action and trying to decide about when to enter or exit the market.