Market Strength: Relative Strength Index and Arms
AAA
  1. Market Strength: Introduction
  2. Market Strength: S&P 500 Futures
  3. Market Strength: Advancers to Decliners
  4. Market Strength: Relative Strength Index and Arms
  5. Market Strength: Oil and Bonds
  6. Market Strength: Conclusion
Market Strength: Relative Strength Index and Arms

Market Strength: Relative Strength Index and Arms


Relative Strength
When talking about the strength of a stock or overall market, one great tool is the relative strength index (RSI) which is a comparison between the days a stock finishes up against the days it finishes down. It is a big tool in momentum trading. Depending on the type of investor, the RSI can be used to detect strength over a couple hours or over several months. Obviously, the longer trends are more valuable to long-term investors, whereas short-term trends in the RSI are popular with traders.


RSI = 100 - [100/(1 + RS)]

where:
RS = (Avg. of n-day up closes)/(Avg. of n-day down closes)
n= days (most analysts use 9 - 15 day RSI)

The RSI ranges from 0 to 100. A stock is considered overbought around the 70 level - a reason to consider selling. This number is not written in stone, in a bull market 80 is a better level because stocks often trade at higher valuations. Likewise, if the RSI approaches 30, a stock is considered oversold - a cause consider buying it. Again, make the adjustment to 20 in a bear market.

A long-term RSI is more rolling and it fluctuates a lot less. Different sectors and industries have varying threshold levels when it comes to the RSI. Stocks of some industries will go as high as 75-80 before dropping back and others have a tough time breaking past 70. A good rule is to watch the RSI over the long term (one year or more) to determine at what level the RSI has traded in the past.

This chart was supplied by Barchart.com

Here we have an RSI chart for AT&T (T). The RSI is the green line and its scale is the numbers that go from 0 to 100. Notice that the RSI was approaching the 60-70 level and then the stock (blue line) sold off, both in December and January. Also notice around October when the RSI dropped to 25 the stock climbed up nearly 30% in just a couple of weeks.




Arms Index
(TRIN)
The Arms Index is commonly referred to on financial television and short-term trading websites. Arms is a market performance indicator that varies from the A/D and RSI because instead of simply looking at the number of up and down ticks (or stocks) the Arms Index weighs each stock by the volume traded for each issue. A ratio of one means that the market is in balance. A ratio above one indicates that more volume is moving into declining stocks. A ratio below one indicates that more volume is moving into advancing stocks.

Both the RSI and Arms are great little indicators that can help you detect the overall strength of the market. Most investors agree that the RSI and Arms is most effective in "backing up" or increasing confidence before making an investment decision.
Market Strength: Oil and Bonds

  1. Market Strength: Introduction
  2. Market Strength: S&P 500 Futures
  3. Market Strength: Advancers to Decliners
  4. Market Strength: Relative Strength Index and Arms
  5. Market Strength: Oil and Bonds
  6. Market Strength: Conclusion
Market Strength: Relative Strength Index and Arms
RELATED TERMS
  1. Earnings Per Share - EPS

    The portion of a company's profit allocated to each outstanding ...
  2. Return On Investment - ROI

    A performance measure used to evaluate the efficiency of an investment ...
  3. Money Flow Index - MFI

    A momentum indicator that uses a stock’s price and volume to ...
  4. Subprime Meltdown

    The sharp increase in high-risk mortgages that went into default ...
  5. Net Present Value - NPV

    The difference between the present value of cash inflows and ...
  6. Event Risk

    1. The risk due to unforeseen events partaken by or associated ...
  1. What is the formula for calculating compound annual growth rate (CAGR) in Excel?

    The concept of CAGR is relatively straightforward and requires only three primary inputs: an investments beginning value, ...
  2. What are some common traits of undervalued stocks?

    There are a few basic factors found in companies that are worth more than their current stock price.
  3. What are the best indicators for evaluating technology stocks?

    Technology stocks are often some of the most discussed stocks on the news. How can investors spot the company that will roll ...
  4. How does Warren Buffett choose the companies he buys?

    Investors have long praised Warren Buffett’s ability to pick great companies to invest in. Lauded for consistently following ...
comments powered by Disqus
Related Tutorials
  1. Macroeconomics
    Economics

    Macroeconomics

  2. Capital Budgeting
    Investing Basics

    Capital Budgeting

  3. Introduction to Stock Trader Types
    Active Trading Fundamentals

    Introduction to Stock Trader Types

  4. Guide to Pairs Trading
    Trading Strategies

    Guide to Pairs Trading

  5. Applying The MACD Indicator With MetaTrader 4
    Trading Systems & Software

    Applying The MACD Indicator With MetaTrader 4

Trading Center