RSI: The Complete Guide to Relative Strength Index
The RSI is one of the most widely used momentum indicators in technical analysis. Learn how to use it to identify overbought and oversold conditions, spot divergences, and make better trading decisions.
What is RSI?
The Relative Strength Index (RSI) is a momentum oscillator developed by J. Welles Wilder Jr. in 1978. It measures the speed and magnitude of recent price changes to evaluate whether a stock is overbought or oversold.
The RSI oscillates between 0 and 100, with readings above 70 traditionally considered overbought and readings below 30 considered oversold. However, these thresholds can be adjusted based on market conditions and your trading strategy.
💡 Key Fact
RSI was originally designed for commodities but has become one of the most popular indicators for stocks, forex, and cryptocurrency trading.
How RSI Works
The RSI calculation compares the average gains to average losses over a specified period (typically 14 periods). Here's the formula:
RSI = 100 - (100 / (1 + RS))
Where RS = Average Gain / Average Loss
The calculation process involves these steps:
- Calculate price changes: For each period, determine if the price went up or down
- Separate gains and losses: Average all gains and all losses separately over the lookback period
- Calculate RS: Divide average gain by average loss
- Apply the formula: Convert RS to the 0-100 scale
Most trading platforms calculate this automatically, so you rarely need to do it manually. The important thing is understanding what the number represents.
Overbought and Oversold Conditions
The traditional interpretation of RSI levels is straightforward:
Price may be due for a pullback. Consider taking profits on long positions or looking for short opportunities.
No extreme conditions. Look for other signals or wait for RSI to reach extreme levels.
Price may be due for a bounce. Consider buying opportunities or covering short positions.
⚠️ Important Warning
Overbought doesn't mean "sell immediately" and oversold doesn't mean "buy immediately." Strong trends can keep RSI in extreme territory for extended periods. Always confirm with other indicators.
RSI Divergence: The Hidden Signal
Divergence occurs when price and RSI move in opposite directions. This is often a powerful signal that the current trend may be weakening.
Bullish Divergence
Price makes a lower low, but RSI makes a higher low. This suggests selling pressure is weakening and a reversal to the upside may be coming.
Bearish Divergence
Price makes a higher high, but RSI makes a lower high. This suggests buying pressure is weakening and a reversal to the downside may be coming.
🎯 Pro Tip
Divergence signals are most reliable on higher timeframes (4H, Daily, Weekly). On lower timeframes, they can produce many false signals.
RSI Trading Strategies
Strategy 1: Centerline Crossover
The 50 level acts as a centerline. When RSI crosses above 50, momentum is bullish. When it crosses below 50, momentum is bearish. Use this for trend confirmation rather than entry signals.
Strategy 2: Failure Swings
A bullish failure swing occurs when RSI drops below 30 (oversold), bounces back above 30, pulls back but stays above 30, then breaks its prior high. This pattern often precedes price reversals.
Strategy 3: RSI + Support/Resistance
Combine RSI with price action. Look for oversold RSI readings at support levels for buying opportunities, or overbought readings at resistance for selling opportunities.
Example Trade Setup
- Identify a strong support level on the chart
- Wait for price to approach this support
- Confirm RSI is below 30 (oversold)
- Look for a bullish candlestick pattern at support
- Enter long with stop loss below support
Best RSI Settings
The default RSI setting is 14 periods, but you can adjust this based on your trading style:
| Period | Trading Style | Characteristics |
|---|---|---|
| 7-9 | Day Trading / Scalping | More signals, more noise, requires fast execution |
| 14 | Swing Trading (Default) | Balanced sensitivity, most widely used |
| 21-25 | Position Trading | Fewer signals, smoother line, stronger signals |
For overbought/oversold levels, consider adjusting based on market conditions:
- Trending markets: Use 80/20 levels to avoid premature entries against the trend
- Ranging markets: Standard 70/30 levels work well
- Volatile assets (crypto): Consider 75/25 or even 80/20
Common RSI Mistakes to Avoid
Trading RSI Alone
RSI should be combined with price action, support/resistance, and other indicators. Never trade based on RSI signals in isolation.
Ignoring the Trend
In strong uptrends, RSI can stay overbought for weeks. In downtrends, it can remain oversold. Always consider the larger trend.
Using the Same Settings for Everything
Different assets and timeframes may require different RSI settings. Test and optimize for your specific market.
Missing Divergence Setups
Many traders only look at overbought/oversold levels. Divergence can be even more powerful for spotting reversals.
Key Takeaways
RSI measures momentum on a 0-100 scale, with 70+ overbought and 30- oversold
Divergence between price and RSI often signals upcoming reversals
Always combine RSI with price action and support/resistance levels
Adjust settings based on your timeframe and trading style
RSI can stay extreme in strong trends—don't fight the trend