V.11:2 (57-60): Relative Momentum Index: Modifying RSI by Roger Altman

Relative Momentum Index: Modifying RSI by Roger Altman

Overbought/oversold indicators are popular among traders for identifying market turns. The relative strength index (RSI) is one such popular indicator. Here, Roger Altman presents his work on modifying the index to smooth the indicator's sensitivity to momentum and the benefits that result.

When a technical indicator such as a moving average or stochastics fails to give a timely signal, it is almost always due to the indicator's lookback period being out of phase with price movement. For most indicators to work properly, they need to use an accurate lookback value. Unfortunately, there is no correlation between the best lookback value from one period to another, and that is why most technical indicators are unreliable. But not all.

J. Welles Wilder's relative strength index (RSI) has been one of the most popular overbought/oversold indicators since its publication in New Concepts in Technical Trading Systems in 1978. A notable attribute of the RSI is that its response to price fluctuations is insensitive to its sole parameter, the lookback period (value X shown in sidebar "The RSI and the RMI"). But the RSI is not always easy to interpret, because it doesn't oscillate evenly between overbought and oversold regions (Figure 1 gives an example for the Standard & Poor's 500). To compensate for this erratic behavior, technicians often use trendlines as well as support and resistance analysis of the RSI itself to help anticipate reversal points. These techniques have done little to improve the reliability of the relative strength index because chart analysis is more an art (that is, subjective) than it is a science (that is, objective) and, therefore, almost impossible to test statistically by computer.