Apple Daily --- Sept 24, 2000

RSI (Relative Strength Index) is one of the most widely used indicator in Technical Analysis. The reason for its popularity is its reliability and simplicity.

The formula for the RSI is quite complex. However, the logic is very simple. Basically, it measures how much the market rises versus how much it falls over the most recent period of time. If during rising days the market gains little but during falling days it loses a lot, it means that the market lacks strength and upward momentum. Selling pressure is stronger than buying ones.

The scale of RSI is from 0 to 100. High values mean that the market is in a strong uptrend but overbought while low values mean a strong yet oversold downtrend. Generally, over 70 means overbought while under 30 means oversold.

One use of the RSI is to buy when the stock is oversold and sell when it is overbought. However, this is a very dangerous strategy, especially during trending markets. When a market keeps trending, the RSI will stay in the overbought region for a long time. Yet, the market may never undergo correction. The fact that the market is overbought does not necessarily mean that it must fall.

Another popular and more reliable use of RSI is divergence. Suppose the market is filled with many positive news and earnings announcements and price makes a new high everyday, with investors rushing desperately into the market. Under this optimistic environment, if we notice that the RSI is not making a new high, but instead topping out, we have to be careful. The market is losing momentum. Buying forces are slowly exhausting. On the other hand, divergence also occurs when price makes a new low but RSI does not follow suit. This signifies that though price keeps falling with negative news filling everywhere, the market is actually picking up steam quietly and gradually gaining strength.

In its original formula, RSI is calculated using closing prices. At this stage, readers should realize that actually we can re-calculate a new type of RSI using Modal Point instead. Let call it P-RSI (Prosticks-RSI).

Using Modal Points to calculate RSI may be different than closing prices. This is because sometimes even though price rises, the Modal Points may actually fall. Thus, both RSI indicators yield different results.

Figure 1 shows the Prosticks chart of Cheung Kong (0001) with the P-RSI indicator plotted below. Notice that at A, price makes a new high (compared to B, the previous major high). However, the RSI fails to make a new high and is falling. This is a divergence situation. The result? The market tumbles over 10% in the following week. Besides, take a note at D. D makes a new low (compared to C, the previous major low). However, the RSI fails to make a new low and is rising. This is also a divergence situation. As can be seen, a powerful uptrend starts from D.

Figure 2 shows the Prosticks chart of Cheung Kong with the traditional RSI indicator plotted below. As can be seen at B and D, using the traditional RSI, the divergence situation are not conspicuous in both cases.

This example serves to demonstrate that RSI calculated from Modal Points sometimes fare better than the traditional one calculated using closing prices. Why? Because closing price is only one price. It is subject to manipulation or random movements. Modal Points, on the other hand, are derived from the accumulated trading volume throughout the whole day. They are more reliable.

As can be seen from both figures, actually the RSI calculated using both approaches are quite similar, except when the market is at the top or bottom. Thus, at market tops and bottoms, readers should consult both RSI and monitor subtle changes occurred in the market trend.

The official website of Prosticks (www.prosticks.com) allow users to specify whether to calculate RSI using the traditional closing prices or the Modal Points. This applies to other popular indicators also such as Moving Averages, Stochastics, Momentum etc.