Relative Strength Index (RSI)

The Relative Strength Index (RSI) is a momentum oscillator used in technical analysis to measure the speed and magnitude of recent price changes. Plotted as a line on a 0–100 scale, it helps identify overbought and oversold conditions, potential trend reversals, and momentum shifts.

Key points

• RSI ranges from 0 to 100.
• Common thresholds: above 70 = overbought, below 30 = oversold. These are adjustable based on trend context.
• Default look-back period: 14 periods.
• Works best in trading ranges; signals in strong trends can remain extreme for long periods.

How RSI is calculated

The standard RSI calculation uses average gains and losses over a look-back period (usually 14):

1. Compute the average gain and average loss over N periods.
2. Calculate the relative strength (RS):
   RS = Average Gain / Average Loss
3. Convert RS to RSI:
   RSI = 100 – (100 / (1 + RS))

For smoothing after the initial calculation, use exponential smoothing:
* New Avg Gain = [(Prev Avg Gain × (N − 1)) + Current Gain] / N
* New Avg Loss = [(Prev Avg Loss × (N − 1)) + Current Loss] / N

This smoothing prevents RSI from immediately jumping to extreme values and makes it respond more steadily to momentum changes.

Interpreting RSI

• Above 70 — commonly considered overbought (possible sell signal or caution for long positions).
• Below 30 — commonly considered oversold (possible buy signal or caution for shorts).
• Around 50 — neutral balance between bulls and bears.

Context matters: in strong uptrends the RSI may stay above 30 and frequently reach 70; in strong downtrends it may stay below 70 and often reach 30. Adjust thresholds accordingly (e.g., 40/60 or other bands) when trading with a clear trend.

Using RSI with trends

• Fit RSI levels to the primary trend: in uptrends, consider higher oversold support (e.g., 40) rather than 30; in downtrends, consider lower overbought resistance (e.g., 60) rather than 70.
• Favor trade signals that align with the trend: use bullish signals in uptrends and bearish signals in downtrends to reduce false signals.
• Combine RSI with trendlines, moving averages, or price structure for confirmation.

Common RSI signals and patterns

Bullish and bearish levels

• Bullish: RSI crossing back above oversold thresholds (e.g., above 30) — stronger if in an uptrend or after a pullback to the 40–50 area.
• Bearish: RSI crossing back below overbought thresholds (e.g., below 70) — stronger if in a downtrend or after a rally to the 50–60 area.

Divergence

• Bullish divergence: price makes a lower low while RSI makes a higher low → suggests rising bullish momentum and potential reversal upward.
• Bearish divergence: price makes a higher high while RSI makes a lower high → suggests weakening upside momentum and possible reversal downward.
  Divergences can precede reversals but may produce false signals during strong, persistent trends.

Positive and negative RSI reversals

• Positive (bullish) reversal: RSI makes a lower low while price makes a higher low → bullish sign.
• Negative (bearish) reversal: RSI makes a higher high while price makes a lower high → bearish sign.

Swing rejection (trend-following signal)

Bullish swing rejection:
1. RSI drops into oversold territory.
2. RSI rises back above the oversold threshold (e.g., 30).
3. RSI retraces but stays above oversold territory.
4. RSI breaks its recent high → buy signal.

Bearish swing rejection is the mirror image:
1. RSI rises into overbought territory.
2. RSI falls back below the overbought threshold (e.g., 70).
3. RSI rallies but stays below overbought territory.
4. RSI breaks its recent low → sell signal.

RSI vs. MACD

• RSI measures the speed and magnitude of price changes on a bounded 0–100 scale and is designed to indicate overbought/oversold momentum.
• MACD measures the relationship between two EMAs (typically 12- and 26-period) and highlights changes in trend and momentum via the MACD line and its signal line.
  They measure momentum differently and are often used together for complementary confirmation; they can sometimes give conflicting signals.

Limitations

• In strong trends, RSI can remain overbought or oversold for extended periods — signals may be misleading if used alone.
• Reversal signals are relatively rare and can be hard to distinguish from false alarms.
• Best used with other tools (trend analysis, volume, moving averages) for confirmation.

Choosing RSI settings

• Default: 14 periods — balanced for swing and position trading.
• Shorter periods (5–9): more sensitive, useful for day trading but produce more noise.
• Longer periods (21–30): smoother, suited to longer-term trend following.
  Also consider adjusting overbought/oversold thresholds to match market volatility and trend strength.

Practical guidelines

• Use RSI primarily in range-bound markets; adjust thresholds in trending markets.
• Combine RSI signals with price action and other indicators for higher-probability trades.
• Watch for divergences, but require confirmation (break of structure, volume, or a supporting indicator) before acting.

Quick FAQs

Q: Should I buy when RSI is low?
A: A low RSI (below 30) can indicate oversold conditions, but in a strong downtrend the asset may remain oversold for a long time — wait for confirmation.

Q: What does a high RSI mean?
A: A high RSI (above 70) typically signals overbought conditions and potential for a pullback, but it can persist during strong uptrends.

Q: Is 14 the best RSI period?
A: 14 is the standard default; choose shorter or longer periods based on trading timeframe and desired sensitivity.

Conclusion

The RSI is a widely used, easy-to-interpret momentum oscillator that helps traders spot potential overbought/oversold conditions, divergences, and momentum shifts. Its effectiveness improves when used in context with trend analysis and other technical tools.