RSI (Relative Strength Index)

The Relative Strength Index (RSI) is a momentum oscillator that measures how strong recent gains have been compared with recent losses, on a scale from 0 to 100. J. Welles Wilder introduced it in his 1978 book New Concepts in Technical Trading Systems, and it has become one of the most widely used indicators in trading. High readings show strong upward momentum; low readings show strong downward momentum.

How RSI is calculated#

RS = Average gain ÷ Average loss, over n periods
RSI = 100 − 100 ÷ (1 + RS)

The standard period is 14. Wilder used a smoothed average, similar to an exponential average, so recent changes carry more weight while older ones fade.

Overbought and oversold#

The crucial point many beginners miss: overbought does not mean "sell". In strong uptrends, RSI can stay above 70 for weeks while price keeps rising. Selling every time RSI crosses 70 means fighting the trend. Overbought and oversold readings are most useful in ranges, where price rotates between extremes.

RSI in trends#

Andrew Cardwell and Constance Brown observed that RSI tends to shift ranges with the trend:

• In uptrends, RSI often oscillates between about 40 and 80, with 40 to 50 acting as support.
• In downtrends, it often oscillates between about 20 and 60, with 50 to 60 acting as resistance.

So a pullback in an uptrend where RSI drops to 40 to 45 and turns up can be a better buy signal than waiting for 30.

Divergence#

Divergence is when price and RSI disagree:

• Bearish divergence: price makes a higher high, RSI makes a lower high. Upward momentum is weakening.
• Bullish divergence: price makes a lower low, RSI makes a higher low. Downward momentum is weakening.

Divergence is a warning, not a trigger. Trends can continue with repeated divergences. Combine it with structure, such as a break of the last swing, before acting. See Change of Character.

Trading with RSI#

1. Range trading: buy near support when RSI is oversold and turning up; sell near resistance when overbought and turning down.
2. Trend pullbacks: in an uptrend, buy when RSI pulls back to its trend range support (around 40 to 50) and turns up.
3. Momentum confirmation: a breakout with RSI pushing above 60 or 70 shows strong momentum behind it.
4. Divergence at key levels: bearish divergence at major resistance, or bullish divergence at major support, adds weight to a reversal setup.

Settings#

• 14 periods: the standard.
• Shorter (2 to 9): faster, more extreme readings; popular in short term mean reversion strategies.
• Longer (20 to 25): smoother, fewer signals.
• Some traders use 80 and 20 instead of 70 and 30 to filter for more extreme readings.

You can add the RSI under the price on the TradeLabs AI chart and compare its readings with how price behaved at past swing highs and lows.

Common mistakes#

• Shorting every overbought reading in an uptrend.
• Treating divergence as an entry signal on its own.
• Ignoring the trend and the RSI range shift.
• Over tweaking settings to fit past charts.

Frequently asked questions#

What does RSI measure?#

The relative size of recent gains versus losses, showing the strength of momentum on a 0 to 100 scale.

Is an RSI above 70 a sell signal?#

Not by itself. It shows strong momentum. In uptrends, RSI can stay above 70 for a long time while prices rise.

What is the best RSI setting?#

The default 14 periods works for most traders. Shorter settings suit short term mean reversion; longer ones give smoother readings.

Sources#

• Wikipedia, Relative strength index