RSI — Relative Strength Index

What Is the Relative Strength Index?

The Relative Strength Index (RSI) is a momentum oscillator developed by J. Welles Wilder Jr. and introduced in his 1978 book New Concepts in Technical Trading Systems. It measures the speed and magnitude of recent price changes on a bounded scale from 0 to 100, helping traders determine whether a stock is overbought or oversold.

Unlike trend-following indicators that lag behind price, RSI is a leading indicator that can signal potential reversals before they happen. It compares the average gains to the average losses over a specified period, producing a single value that oscillates between extreme readings. When RSI is above 70, the asset is considered overbought and may be due for a pullback. When RSI is below 30, the asset is considered oversold and may be positioned for a bounce.

How RSI Is Calculated

The RSI formula is straightforward once broken into steps. First, calculate the average gain and average loss over the lookback period (typically 14 bars). Then compute the Relative Strength (RS), which is the ratio of average gain to average loss. Finally, normalize it into a 0–100 range.

1. Separate price changes into gains and losses over the last 14 periods.
2. Calculate the average gain (sum of gains / 14) and average loss (sum of losses / 14).
3. RS = Average Gain / Average Loss (avoid division by zero in live systems).
4. RSI = 100 − (100 / (1 + RS)).

After the initial 14-period calculation, subsequent values use a smoothed average: the previous average is multiplied by 13, the current value is added, and the total is divided by 14. This smoothing makes RSI less volatile on a bar-to-bar basis and more reflective of the underlying trend.

Overbought and Oversold Zones

The default overbought threshold is 70 and the oversold threshold is 30. When RSI rises above 70, it indicates strong buying pressure that may be exhausting. When it drops below 30, it indicates heavy selling pressure that may be nearing capitulation. However, these levels are not automatic buy or sell signals.

In strong uptrends, RSI can remain above 70 for weeks or months. Selling every time RSI hits 70 during a bull market would cause you to exit profitable positions far too early. The better approach is to wait for RSI to actually cross back below 70, confirming that momentum is fading. Similarly, in strong downtrends, RSI can linger below 30 for extended periods. Wait for RSI to cross back above 30 before considering a buy.

Some traders adjust these thresholds to 80/20 for strong-trending markets or 60/40 for range-bound conditions. Andrew Cardwell's approach uses 40–80 in uptrends and 20–60 in downtrends, which often provides more accurate signals.

RSI Divergence

Divergence between RSI and price is one of the most powerful signals the indicator produces. It occurs when price and RSI move in opposite directions, indicating that the current trend is losing momentum.

Bearish divergence appears when price makes a higher high but RSI prints a lower high. This means that although price reached new highs, the internal momentum behind the move was weaker. It frequently precedes trend reversals or at least significant pullbacks. The chart illustration above shows this clearly: price peaks higher at a later candle, but RSI peaks lower than at the prior swing.

Bullish divergence appears when price makes a lower low but RSI prints a higher low. Selling pressure is declining even as price drops to new lows, suggesting that bears are losing conviction. This often precedes bullish reversals, especially when combined with a support level or oversold RSI reading.

Divergence signals are most reliable on daily and weekly charts. On lower timeframes they produce too many false signals. Always confirm divergence with a price-action trigger such as a candlestick reversal pattern or a break of a trendline.

Centerline Crossover Strategy

The RSI 50 level acts as a dynamic support/resistance line for momentum. When RSI crosses above 50, it means average gains are exceeding average losses, confirming bullish momentum. When RSI crosses below 50, bearish momentum has taken over.

Trend-following traders use this as a filter: only take long trades when RSI is above 50, and only take short trades when RSI is below 50. During an uptrend, pullbacks that hold RSI above 40–50 are considered healthy and present buying opportunities. If RSI breaks below 40 during what was thought to be a pullback, it may indicate a deeper correction or trend change.

Common Mistakes

• Selling solely because RSI hit 70. Overbought does not mean overpriced. In strong trends, RSI can stay elevated for a long time. Wait for RSI to actually turn down and cross below 70 before acting.
• Ignoring the broader trend. RSI works best as a confirmation tool within a trend framework. Using RSI in isolation leads to premature entries and exits.
• Using only the default 14 period. Faster-moving assets may benefit from a shorter period (7–9), while slower assets like indices may respond better to a longer period (21).
• Treating divergence as an immediate signal. Divergence warns that momentum is shifting, but it does not tell you exactly when the reversal will happen. Wait for price confirmation before entering.