Technical Indicators & Analysis

RSI: The Relative Strength Index Explained

April 18, 2025 Comments Off on RSI: The Relative Strength Index Explained

Introduction

The Relative Strength Index (RSI) is a widely used momentum oscillator in technical analysis. It helps traders determine whether a stock is overbought or oversold, indicating potential trend reversals.

How RSI Works

RSI is calculated using the following formula:

RSI = 100 – (100 / (1 + RS)) 

Where RS (Relative Strength) is:

RS=AverageGainovernperiodsAverageLossovernperiodsRS = \frac{Average Gain over n periods}{Average Loss over n periods}

  • The standard RSI period is 14 days, but traders adjust it for different timeframes to suit their strategies related to the RSI
  • RSI values range from 0 to 100, with key levels at:
    • Above 70: Overbought – a possible sell signal.
    • Below 30: Oversold – a possible buy signal.

How to Use RSI in Trading

  1. Overbought/Oversold Conditions:
    • Buy when RSI crosses above 30 from oversold conditions of the Relative Strength Index.
    • Sell when RSI crosses below 70 from overbought levels.
  2. Divergence Trading:
    • Bullish Divergence: Price makes lower lows, but RSI makes higher lows → potential uptrend.
    • Bearish Divergence: Price makes higher highs, but RSI makes lower highs → potential downtrend.
  3. Trend Confirmation:
    • RSI staying above 50 indicates bullish strength among the Relative Strength Index indicators.
    • RSI staying below 50 signals bearish strength.

Example of RSI in Trading

  • A stock’s RSI falls to 25, indicating oversold conditions. This is a critical point in observing the Relative Strength Index.
  • If RSI crosses above 30, traders may enter a buy trade.
  • Conversely, if RSI is above 75 and drops below 70, traders may sell.

Advantages of RSI

  1. Simple and Effective: Provides clear trading signals based on the Relative Strength Index.
  2. Works Across Markets: Used in stocks, forex, and crypto trading.
  3. Pairs Well with Other Indicators: Often used with MACD, Bollinger Bands, and Moving Averages.

Limitations

  • False Signals: The Relative Strength Index can remain overbought/oversold for extended periods in strong trends.
  • Needs Confirmation: Best used with volume analysis or trend indicators.

Conclusion

The RSI Indicator is an essential tool for measuring market momentum and detecting trend reversals. By combining RSI with other technical indicators, traders can enhance their strategy and improve decision-making. The Relative Strength Index plays a crucial role in this process.

RSI Chart Example

Below is a real chart illustrating RSI levels and stock price movements:

Relative Strength Index