The RSI Indicator

The Relative Strength Index (RSI) is one of the most popular momentum oscillators. It measures the speed and change of price movements to identify overbought and oversold conditions. [DEFINITION] RSI (Relative Strength Index): A momentum oscillator ranging from 0 to 100 that measures the magnitude of recent price changes to evaluate overbought or oversold conditions. [FORMULA] RSI = 100 - (100 ÷ (1 + RS)) where RS = Average Gain ÷ Average Loss over the period (typically 14 days) ### Interpreting RSI **Traditional levels:** - RSI above 70 = Overbought (potentially overextended) - RSI below 30 = Oversold (potentially undervalued) - RSI at 50 = Neutral [TIP] In strong uptrends, RSI can stay overbought for extended periods. In strong downtrends, RSI can stay oversold. Don't automatically sell just because RSI hits 70. ### Trading Strategies with RSI **Overbought/Oversold:** - Look to sell when RSI > 70 and starts declining - Look to buy when RSI < 30 and starts rising - Combine with other signals for confirmation **Centerline (50) Crossovers:** - RSI crossing above 50 = bullish momentum building - RSI crossing below 50 = bearish momentum building **Divergence:** Most powerful RSI signal [KEY] RSI divergence occurs when price makes a new high/low but RSI does not. This signals weakening momentum and potential reversal. ### RSI Divergence Examples **Bearish Divergence:** - Price makes higher high - RSI makes lower high - Suggests uptrend losing steam [EXAMPLE] Stock rallies from $80 to $100 (RSI 75), pulls back, then rallies to $105 (RSI 65). Despite higher price, RSI is lower—bearish divergence warning. **Bullish Divergence:** - Price makes lower low - RSI makes higher low - Suggests downtrend losing steam [WARNING] Divergence signals reversal potential, not certainty. The divergence can persist for some time before the actual reversal occurs. Use for early warning, not precise timing. ### RSI in Trending Markets **Strong uptrend adjustments:** - Overbought: 80 instead of 70 - Oversold: 40 instead of 30 - Buying pullbacks to 40-50 RSI in uptrends can work well **Strong downtrend adjustments:** - Overbought: 60 instead of 70 - Oversold: 20 instead of 30 [EXERCISE] A stock is in an uptrend. RSI was 72 at the previous high of $50. Now price is at $55 (new high), but RSI is only 65. What type of divergence is this, and what does it suggest? |ANSWER| This is bearish divergence. Price made a higher high ($55 vs $50) but RSI made a lower high (65 vs 72). This suggests the uptrend momentum is weakening, and a pullback or reversal may be coming. It doesn't mean sell immediately, but be cautious. [SCENARIO] You're looking at a stock that's dropped 40% in 3 months. RSI is at 22 (deeply oversold). Should you buy? Not necessarily. RSI at 22 means the decline has been sharp, but oversold can get more oversold in strong downtrends. Look for RSI to turn up, combined with other bullish signals (support holding, bullish candlestick, improving fundamentals) before buying.