We care that you succeed
Bringing readers the latest happenings from the world of Trading and Investments specifically and Finance in general.
With so many technical terms and technical trading tools in the stock market, it is easy to be bowled over when you are only trying to get started with your journey. Note that many things have changed in the market over the years; for example, online trading and trading tools such as market screeners, indicators and charts have made things much more convenient for traders as far as possible.
Published on 27 January 2022
But what remains to be grasped is the use and the understanding of technical terms, without which it can become inconvenient to use these tools.
Two of these terms that many traders struggle with is the difference between relative strength vs relative strength index. Don’t they sound just the same and appear to relate to each other? This is where the confusion begins. And so, let’s find out why relative strength and relative strength index are not the same.
Relative strength is a momentum investing strategy used by investors to pick value stocks. In momentum investing, the stocks are chosen because their performance beats the benchmark or the market, and it is assumed that such stocks will continue performing well. To make this choice, it is necessary to compare stocks in a peer group from the same sector with one another based on various parameters such as the yield, the cap size, type, index, etc.
Since these investors choose from several stocks, relative strength helps them compare and find suitable combinations of securities or stocks instead of carrying out an individual analysis of each stock. Technical analysts also use relative strength to buy high and sell higher.
The Relative Strength Index or the RSI is used in technical analysis of recent price movements. This tool is also used in momentum investing. The RSI shows values between 0-100, where an RSI value of above 70 shows that the stock is being overbought and is, therefore, overvalued. Conversely, an RSI of below 30 signals that the stock is oversold and hence, undervalued.
Developed in 1978, the RSI, as a momentum oscillator, has helped technical traders understand whether the price movement is bullish or bearish. In RSI trading, the RSI chart is placed below the stock or security’s price chart to help traders compare the momentum to the market price. However, the RSI must be used in combination with another technical tool such as the Stochastic Oscillator or Bollinger Bands for more accurate results.
One of the main points of differentiation between relative strength vs relative strength index is how the calculation is carried out.
To calculate the relative strength, consider the prices of two stocks and divide the price of the reference stock by the other(base stock).
When calculating the relative strength, the past prices of the stock will also have to be considered.
Let’s see how the Relative Strength Index is calculated in two steps.
RSI Step One = 100 – [100/ 1+ average gain/average loss]
Traders use the values of 14 timeframes to compute the initial RSI. Once this data has been computed and the 14 intervals are calculated, they can use the next step.
RSI Step 2 = 100 – [100/ 1 + (previous avg. gain*13+current gain)/ (previous avg. loss *13+current loss)]
The second formula is used to refine the first result, which means the value will be closer to 0 or 100 when the market shows a strong trend.
The relative strength and RSI are important for traders and investors in the market, but these concepts and tools should first be understood in detail before they are applied in practice.
Also Read: How to Invest in Stock Market?
We care that you succeed