  |
 |
FRED GOODMAN'S KEY INDICATORS FOR
INVESTMENT SUCCESS
There are at least three ways to calculate the 14-day Relative Strength Indicator (RSI). All of them use the original formula invented by Welles Wilder to derive a value from the average daily percent advance and the average daily percent decline of a stock or index. However, the methods for determining the 14-day averages can be different. Periodically I hear from a reader using a method different from the one with which I have become accustomed. The next three charts compare three methods of calculation, two at a time. In the first chart I have plotted in light blue the method I have been using for years. Notice that the extremes reached are greater than those reached by the other calculation. The light blue line also moves a bit more rapidly than the rose line, which is determined from exponential smoothing to calculate the daily average changes. The blue line is based on a simple moving average instead of exponential smoothing. However, I am certain that you will agree that the differences between these two methods are minor.
In this chart the exponential smoothing method was used to determine the light blue line. It is precisely the same as the rose line above. In this chart the rose line is used to demonstrate the original Wilder method. You will see that while the extremes reached by either method coincide with each other on a basis of time, but the use of exponential smoothing leads to much greater amplitude. If one believes that the 30% and 70% levels are key to the application of the RSI indicator, the Wilder calculation is probably the better one to use since buy and sell signals occur less frequently.
Finally, just for completeness, here is a comparison of the simple moving average method appearing in these reports, to the Wilder original method. If you have the desire to know the precise calculations, please let me know and I will be happy to provide them.
Fred Goodman, CFP, is a fee-only Certified Financial Planner based in Los Angeles. You can send him your questions and comments via email at Fred@MarketMonograph.com. The charts and commentary represent what Fred is thinking about the market and thinking of doing for his own account and for accounts he manages. There is no guarantee that you will profit from trading as discussed herein. You may lose money and Fred assumes no responsibility for what you do or do not do with this information. 
|
