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- PREV DEFINITIONRecord DateThe issuing company fixes a particular date when the investor must own shares in order to be eligible to participate in corporate events. This is called record date.Read More
- NEXT DEFINITIONRequired Rate of returnDefinition: Required Rate of return is the minimum acceptable return on investment sought by individuals or companies considering an investment opportunity. Description: Investors across the world use the required rate of return to calculate the minimum return they would accept on an investment, after taking into consideration all available options. When calculating the required rate of return, investors look at overall market returns, risk-free rate of return, volatility of the stock and overall project cost. The required rate of return drives the type of investments that can be made. For instance, someone requiring a higher rate of return would necessarily have to look at riskier investments. Finance professionals routinely calculate the required rate of return for purchasing new equipment, new product rollouts and potential mergers. For example: an investor who can earn 10 per cent every year by investing in US Bonds, would set a required rate of return of 12 per cent for a riskier investment before considering it. Formula for Required Rate of Return Required Rate of Return = Risk Free Rate + Risk Co-efficient (Expected Return - Risk free return)Read More

RSI = 100 – (100/1+RS)

RS (Relative Strength) = Average of X days up closes / Average of X days down closes

Wilder used the 14 day RSI, which is still the most commonly used RSI. However, an analyst is free to decide the number of days for computing the same.

For example, during a 14-day trading period assume that a security has generated positive returns on 9 days and negative returns on 5 days. In this case, the Relative Strength Index is calculated as follows

1. Calculate the absolute gain in each of the 9 up days. Add the absolute gain of each day and divide by 14. This will give the figure of average up closes.

2. Calculate the absolute loss in each of the 5 days. Add the absolute loss of each day and divide by 14. This will give the figure of average down closes.

3. Dividing the average up closes or gains by the average down closes or losses gives us the Relative Strength.

4. The figure is further normalised using the above formula so as to ensure that it lies between 0 and 100.

For computing the next RSI, the following steps are followed

1. For calculating the next average gains, multiply the previous average gains by 13 and add today’s gains if any and divide the result by 14. In our previous example, we will multiply the average absolute gains of 9 days and add today’s absolute gain (if any) and divide the result by 14.

2. For calculating the next average losses, multiply the previous average losses by 13 and add today’s loss if any and divide the result by 14. In our example, we will multiply the average absolute losses of 5 days and add today’s absolute loss (if any) and divide by 14.

3. The next step involves dividing the average gains by the average losses for getting the figure of Relative Strength.

4. Finally, the RSI is found using the formula RSI = 100 – (100/1+RS)

The following inferences can be drawn from Relative Strength Index

1. Overbought and Oversold levels: RSI gives an indication of the impending reversals or reaction in price of a security. RSI moves in the range of 0 and 100. So an RSI of 0 means that the stock price has fallen in all of the 14 trading days. Similarly, an RSI of 100 means that the stock price has risen in all of the 14 trading days. In technical analysis, an RSI of above 70 is considered an overbought area while an RSI of less than 30 is considered as an oversold area. RSI can be used as a leading indicator as it normally tops and bottoms ahead of the market, thereby indicating an imminent correction in the price of a security. It is pertinent to note that the levels of 70 and 30 needs to be adjusted according to the inherent volatility of the security in question.

In this chart, the RSI touches the 70 mark, the threshold of overbought zone then falls to 60. This is called the fail point. Post that, it moves again but rises less than the previous high of 70, thereby, creating a failure swing. It then falls below the fail point there creating a bearish failure swing. It acts as a signal for the trader to go for a short position in the security.

In this chart, the RSI touches the 30 mark, the threshold of oversold zone and then rises to 40, the fail point. It then falls again but the fall is lower than the previous value of 30. Moreover, the RSI crosses the fail point to rise even higher thereby creating a bullish failure swing. It acts as a signal for a trader to go for a long position in the security.

The 14-day RSI of stock prices of Reliance Power in NSE. The overbought level set at over 70 and oversold level set at below 30.

Source

According to Wilder, the RSI used together with bar chart can provide pivotal inputs to an analyst for drawing inferences from a chart.

- PREV DEFINITIONRecord DateThe issuing company fixes a particular date when the investor must own shares in order to be eligible to participate in corporate events. This is called record date.Read More
- NEXT DEFINITIONRequired Rate of returnDefinition: Required Rate of return is the minimum acceptable return on investment sought by individuals or companies considering an investment opportunity. Description: Investors across the world use the required rate of return to calculate the minimum return they would accept on an investment, after taking into consideration all available options. When calculating the required rate of return, investors look at overall market returns, risk-free rate of return, volatility of the stock and overall project cost. The required rate of return drives the type of investments that can be made. For instance, someone requiring a higher rate of return would necessarily have to look at riskier investments. Finance professionals routinely calculate the required rate of return for purchasing new equipment, new product rollouts and potential mergers. For example: an investor who can earn 10 per cent every year by investing in US Bonds, would set a required rate of return of 12 per cent for a riskier investment before considering it. Formula for Required Rate of Return Required Rate of Return = Risk Free Rate + Risk Co-efficient (Expected Return - Risk free return)Read More