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Questions and Answers
What is one of the primary uses of the Accumulation/Distribution line?
What is one of the primary uses of the Accumulation/Distribution line?
Which combination of indicators is advised against using together?
Which combination of indicators is advised against using together?
What does a negative divergence between the price chart and the A/D line suggest?
What does a negative divergence between the price chart and the A/D line suggest?
Which calculation is used to determine Close Location Value (CLV)?
Which calculation is used to determine Close Location Value (CLV)?
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According to Wilder’s recommendations, which type of indicators are suggested to filter out fake signals?
According to Wilder’s recommendations, which type of indicators are suggested to filter out fake signals?
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What does the RSI primarily help traders to identify in the market?
What does the RSI primarily help traders to identify in the market?
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What is the default parameter period for calculating the RSI?
What is the default parameter period for calculating the RSI?
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What value indicates the market is considered overbought according to the RSI?
What value indicates the market is considered overbought according to the RSI?
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What is calculated as RS in the RSI formula?
What is calculated as RS in the RSI formula?
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When should traders consider entering a sell position based on RSI signals?
When should traders consider entering a sell position based on RSI signals?
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Why is the RSI indicator not advisable to use in strongly trending markets?
Why is the RSI indicator not advisable to use in strongly trending markets?
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Which of the following values indicates a market that is oversold according to RSI?
Which of the following values indicates a market that is oversold according to RSI?
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What occurs when the RSI moves around the neutral line at 50?
What occurs when the RSI moves around the neutral line at 50?
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Study Notes
Indicators
- RSI (Relative Strength Index) created by Welles Wilder (1978) is a momentum oscillator
- RSI aims to identify market situations where the stock is either too expensive or too cheap
- The default parameter for RSI is 14, but other parameters (e.g., 9 and 25) can be used
RSI Calculation
- RS is calculated as the average of raw close-up prices divided by the average of raw close-down prices.
- Then, RSI is calculated using the formula: RSI = 100 - (100 / (1 + RS))
RSI Calculation Example (14-period)
- Record closing prices for 14 periods
- Calculate the number of times the closing price was higher than the previous one (H)
- Calculate the number of times the closing price was lower than the previous one (L)
- Calculate RS = H/L
- Utilize the formula RSI = 100 - (100 / (1 + RS)) to calculate RSI
RSI Usage
- Oscillator operating around the neutral line (50).
- Important levels: 30 and 70 (or 20 and 80).
- Values above 70 indicate overbought conditions.
- Values below 30 indicate oversold conditions.
- Entry signals:
- Cross above 70 with downward movement suggests a sell entry.
- Cross below 30 with upward movement suggests a buy entry.
- Neutral line: 50
RSI Application (Example with IBM)
- RSI graph is overlaid on a stock chart.
- RSI value may be useful in determining when the overbought or oversold conditions are present
- The overbought and oversold zones are usually indicated in charts above 70 or below 30
RSI Combinations with Other Indicators
- RSI is not optimal for strong trend markets.
- Avoid combining RSI with other indicators like Stochastic, or Williams %R, because they often lead to duplicate or contradictory signals.
- Wilder recommends employing trend indicators (like ADX) to filter spurious signals.
RSI Failure Signals
- Failure swings (tops and bottoms) occur when the price fails to reach a previous extreme.
- Top failures occur when the price doesn't exceed a previous high while RSI may still signal a potential selling opportunity.
- Bottom failures occur when the price does not exceed a past low.
Divergence in RSI
- RSI divergence occurs when a security's price makes a new high or low, but its RSI does not.
- When price and RSI make opposing movements, this is called divergence.
- Bearish divergence: Occurs when price makes a new high, but RSI fails to do so (suggesting a potential sell).
- Bullish divergence: Occurs when price makes a new low, but RSI fails to do so (suggesting a potential buy).
A/D (Accumulation/Distribution) Line
- Developed by Marco Chaikin
- Aims to determine whether buyers or sellers are controlling the market.
- 'Accumulate': Market controlled by buyers
- 'Distribute': Market controlled by sellers.
A/D Calculation
- CLV: Calculates the relative closing price's position. The formula is: CLV = [(Close - Low) - (High - Close)] / (High - Low)
- A/D = CLV * Volume
A/D Usage
- Look for positive/negative divergence.
- Upward price with downward A/D: Traders may be finishing accumulation.
- Downward price with upward A/D: Traders may be finishing distribution
- A/D alone is not for entering positions. It's a supplementary indicator.
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Description
This quiz covers the concept of the Relative Strength Index (RSI) as a momentum oscillator in stock trading. It includes details on RSI calculation, examples, and its usage in identifying overbought or oversold market conditions. Test your knowledge on RSI's principles and applications in financial markets.
