Key Takeaways
- RSI measures momentum of price movements.
- Values above 70 signal overbought conditions.
- Values below 30 signal oversold conditions.
- Divergences indicate potential trend reversals.
What is Relative Strength Index (RSI)?
The Relative Strength Index (RSI) is a popular momentum oscillator used in technical analysis to measure the speed and magnitude of recent price changes. It helps you identify overbought or oversold conditions in assets by comparing recent gains to losses over a set period, typically 14 days.
Developed by J. Welles Wilder Jr., RSI displays values from 0 to 100, signaling potential turning points in market momentum rather than fundamental value.
Key Characteristics
RSI offers clear, actionable insights through its simple scale and calculation.
- Oscillator Range: RSI values range between 0 and 100, indicating momentum strength.
- Overbought/Oversold Thresholds: Levels above 70 typically denote overbought, while below 30 indicate oversold conditions.
- Calculation Method: RSI uses average gains and losses over a period to compute relative strength.
- Flexibility: Period length can be adjusted to fit your trading style or strategy.
- Data Smoothing: RSI applies smoothing techniques to reduce noise, closely related to data smoothing concepts.
How It Works
RSI calculates the ratio of average upward price movements to average downward movements, converting this into a momentum score between 0 and 100. This score helps you evaluate whether buying or selling pressure dominates recently.
Values above 70 suggest that an asset may be overbought and due for a pullback, while values below 30 imply oversold conditions that may signal a rebound. However, in strong trends, RSI can stay elevated or depressed longer, so combining RSI with tools like regression analysis or trend confirmation is prudent.
Examples and Use Cases
RSI is widely used across various markets and investment types to time entries and exits.
- Equities: Traders might use RSI when analyzing growth stocks featured in our best growth stocks guide to identify potential reversals or confirm momentum.
- ETFs: When managing diversified portfolios, RSI helps evaluate ETFs like SPY for short-term momentum shifts within large-cap U.S. equities.
- Airlines: Monitoring companies like Delta during volatile periods can benefit from RSI signals to time buy or sell decisions amid fluctuating market sentiment.
Important Considerations
While RSI provides valuable momentum insights, it should not be used in isolation. Overbought and oversold readings are guidelines, not guarantees of reversals, especially in trending markets where RSI can remain extreme for extended periods.
Combining RSI with other analysis techniques, such as those covered in our best ETFs for beginners guide or applying broader market context, improves its reliability and your trading decisions.
Final Words
RSI highlights when an asset may be overbought or oversold, signaling potential price reversals. Monitor RSI levels alongside other indicators to refine your entry and exit points in trading.
Frequently Asked Questions
The Relative Strength Index (RSI) is a momentum oscillator that measures the speed and magnitude of recent price movements to indicate overbought or oversold conditions in financial markets.
RSI is calculated using the formula 100 minus 100 divided by one plus the Relative Strength (RS), where RS is the average gain divided by the average loss over a specified period, usually 14 days.
RSI values above 70 typically indicate overbought conditions suggesting a possible price retracement, values below 30 indicate oversold conditions suggesting undervaluation, and values between 30 and 70 indicate neutral momentum.
In ranging markets, RSI oscillates cleanly between overbought and oversold levels, making mean reversion signals reliable, whereas in trending markets RSI may stay above 70 or below 30 for extended periods, making those signals less reliable without trend context.
Yes, traders use RSI divergences, failure swings, and centerline crossovers as additional signals to predict potential price reversals or confirm trend direction.
The RSI was developed by J. Welles Wilder Jr. and introduced in his 1978 book, New Concepts in Technical Trading Systems.
Manual calculation of RSI is rarely necessary since most trading platforms automatically compute it based on price data and the chosen period.
