RSI (Relative Strength Index) is one of the most popular momentum indicators. It measures the speed and magnitude of price changes to identify overbought and oversold conditions. Here is how it works.
What is RSI?
RSI is a momentum oscillator that ranges from 0 to 100. It compares recent gains to recent losses to determine if an asset is overbought or oversold.
Simple concept: RSI measures how strong recent up moves are compared to recent down moves. High RSI means lots of buying. Low RSI means lots of selling.
RSI Levels
- Above 70: Overbought - the asset may have risen too fast
- Below 30: Oversold - the asset may have fallen too fast
- Around 50: Neutral - no strong momentum either way
The standard RSI period is 14 (14 days on daily charts).
How to Use RSI
1. Overbought/Oversold Signals
The traditional use of RSI:
- RSI above 70 = potentially overbought, consider selling
- RSI below 30 = potentially oversold, consider buying
Warning: RSI Can Stay Extreme
In strong trends, RSI can stay overbought or oversold for extended periods. Do not blindly trade against the trend just because RSI is extreme.
2. RSI Divergence
Divergence occurs when price and RSI move in opposite directions. It can signal a potential reversal.
- Bullish divergence: Price makes lower low, but RSI makes higher low. Suggests upside.
- Bearish divergence: Price makes higher high, but RSI makes lower high. Suggests downside.
Bullish Divergence Example
Stock drops from $100 to $90, RSI drops to 25.
Stock drops further to $85, but RSI rises to 30.
Price made a lower low ($85 < $90), but RSI made a higher low (30 > 25).
This bullish divergence suggests selling pressure is weakening.
3. RSI Centerline Crossover
- RSI crossing above 50 = bullish momentum
- RSI crossing below 50 = bearish momentum
RSI Trading Strategies
Mean Reversion Strategy
- Buy when RSI drops below 30 and starts turning up
- Sell when RSI rises above 70 and starts turning down
- Works best in range-bound markets
Trend Confirmation Strategy
- In uptrends, buy when RSI pulls back to 40-50 zone
- In downtrends, sell when RSI bounces to 50-60 zone
- Works best in trending markets
RSI Settings
- 14 period: Standard, most common
- 9 period: More sensitive, more signals, more noise
- 21 period: Less sensitive, smoother, fewer signals
Limitations of RSI
- Can remain overbought/oversold in strong trends
- Divergence does not always lead to reversal
- Works better in range-bound than trending markets
- Should be used with other indicators for confirmation
Track Your RSI-Based Trades
Pro Trader Dashboard helps you analyze which RSI setups work best for your trading.
Summary
RSI measures momentum on a scale of 0 to 100. Traditional signals are overbought above 70 and oversold below 30. RSI divergence can signal potential reversals. Remember that RSI can stay extreme in strong trends, so always consider the broader context before trading RSI signals.
Learn more: MACD indicator and Bollinger Bands.