How the look-back periods impact Relative Strength Index

Chart 1 demonstrates the RSI (5) for the Dow Jones Industrial Average Index from 7/27/2012 to 7/26/2013.  It shows that when the stock market went up, the RSI rose accordingly. No matter how strong the market was, and how long the RSI stayed in the overbought status, the market eventually took a breath, and experienced profit taking. Then, the RSI swung or approached to an oversold territory.

   

                   Chart 1 RSI (5) for Dow Jones Industrial Average Index from 7/27/2012 to 7/26/2013.

                  Source: Line Graph Outline form StockCharts.com.  Actual data compiled by Authors.

If you always buy at oversold and sell at overbought, you will certainly make money in an uptrend or range-bound market.  On the other hand, if you sell or short at overbought, and buy at oversold conditions, you will be a winner in a downtrend stock market.

    Chart 2: RSI (14) for Dow Jones Industrial Average Index from 7/27/2012 to 7/26/2013.

    Source: Line Graph Outline form StockCharts.com.  Actual data compiled by Authors.

Comparing chart 2 with chart 1, chart 1 is for the RSI with 5 as the look-back period, while chart 2 keeps the default look-back period 14. It is obvious that the RSI (5) has larger scales of up and down movement, and is easier to swing between overbought and oversold conditions. Thus, chart 1 shows more sensitivity, since the look-back period has been shortened.  The lower the look-back days, the higher sensitivity the RSI tends to have and the easier the RSI is able to reach the extremes (either overbought or oversold). On the other hand, the cycles and extremes are more insightful for RSI with shorter look-back days

 

Credited to:  

http://www.investopedia.com/terms/r/rsi.asp Relative Strength Index –RSI

http://stockcharts.com/school/doku.php?id=chart_school:technical_indicators:relative_strength_index_rsi Relative Strength Index (RSI).


If you want can read more about RSI, you can visit:

http://top5indicators.blogspot.com/2013/09/how-to-combine-ise-sentiment-index-and.html

http://top5indicators.blogspot.com/2013/09/how-to-determine-bullish-divergence-by.html

http://top5indicators.blogspot.com/2013/09/how-to-determine-market-breakouts-by.html

http://top5indicators.blogspot.com/2013/09/how-to-determine-negative-divergence-by.html

http://top5indicators.blogspot.com/2013/09/how-to-profit-from-stock-market-by_17.html   http://top5indicators.blogspot.com/2013/09/how-to-choose-look-back-periods-for-rsi_12.html