Difference Between Relative Strength vs Relative Strength Index | Espresso

Relative Strength vs Relative Strength Index: What is the Difference?

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.

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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.

What is Relative Strength?

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.

What is the Relative Strength Index?

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.

The difference Between Relative Strength vs Relative Strength Index

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.

Conclusion

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?

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Frequently Asked Questions

The RSI does not have to be high or low; it is an indicator where levels below 30 show that the stock has been oversold and undervalued while levels above 70 indicate that the stock has been overbought and thus, is overvalued. The RSI scale is from 0 to 100.

 

Yes, new investors can start learning how to calculate relative strength and Relative Strength Index before using them practically. It takes time to learn how to use these methods and tools in the market, and to avoid unnecessary risks, it is better to be well-versed with them.

The RSI is considered to be accurate enough, which is why many traders rely on it. But they use it in combination with other technical tools for better accuracy. If needed, RSI can be used along with Bollinger Bands, the Moving Average Convergence Divergence (MACD), Exponential Moving Averages (EMA), Stochastic Oscillator and others.