How to use the Relative Strength Index (RSI)

• What is the Relative Strength Index (RSI) and it’s history
• Finding areas of overbought and oversold using the RSI
• Signals and divergence RSI provides

The Relative Strength Index (RSI) was developed by J. Welles Wilder Jr. ﹣an American mechanical engineer, turned real estate developer, yet best known for bringing to life several technical indicators such as aforementioned Relative Strength Index (RSI), Average True Range, Average Directional Index and the Parabolic SAR.

RSI was published in a 1978 book, New Concepts in Technical Trading Systems, and in ‘Commodities’ magazine (now ‘Futures’ magazine) in the June 1978 issue and quickly became one of the most popular oscillator indices.

The RSI is an oscillating indicator that measures the relative velocity and magnitude of recent changes in price direction. Put more simply, it measures the momentum of price action over time. It is used by traders to identify whether the price of an asset is overbought or oversold. When price moves to one of these extremes, a reversal is usually not far away, although it’s important to bear in mind that overbought and oversold conditions can last for several days at a stretch on the higher time frames.

The RSI level is a measure of the asset’s recent trading strength. The RSI’s slope is directly proportional to the velocity of a change, while the distance traveled is proportional to the magnitude of the move.

The RSI indicator oscillates between 0 and 100 and is charted as a line across a default trading time frame of 14 days for comparing up to down trading periods. 0-50 is generally considered potentially bearish, whereas 50-100 is potentially bullish.

The default settings on the RSI indicator show 30 as an oversold area and 70 as an overbought area. Many traders customize these settings to allow for more room in a volatile market, adjusting the low to 20 and the high to 80. The reason for this is that there is a danger you may fall into the trap of assuming that the values of 70 and 30 are the equivalent of signals to sell or buy. It’s true, they may work this way, but not necessarily.

The trend line you see on the RSI is not predicting price, rather, it is giving you a measure of momentum. The fact is certain instruments can trade at 75-80 for long periods of time. So let’s say you were trading the NASDAQ 100 and you saw the RSI for the daily chart showing an overbought area of around 75. If you were to make the not unreasonable assumption that an overbought security must soon come down, you might be tempted to go short the moment you see the RSI dip a little. This could be a mistake, however, because many assets can ﹣ and do ﹣ trade in overbought areas for long periods of time with price going up and up, not merely sideways. It may be sensible to incorporate other technicals, say the MACD and moving averages, into your strategy before opening a trade based heavily on your reading of the RSI.

As with the MACD, the RSI indicator can be used to identify areas of divergence in price action and momentum. You can see this in action when an asset hits a new high or low in price, but the RSI can be seen moving in the opposite direction.

• When price makes a new high, but the RSI can be seen to dip, you have bearish divergence and a sell signal.
• When price makes a new low and the graph line on the RSI is going up, you have a buy signal.
• When the RSI indicator dips below the overbought line above 70, you are looking at a potential sell signal and when the RSI indicator crosses above the oversold line at 30 you have a potential buy signal

It’s important to remember that the RSI will often provide signals before the information is reflected in the chart. As with most indicators, the RSI is best used alongside other technical indicators, such as the MACD [link to MACD page], to support your reading of the technicals on a chart.

• The relative strength index (RSI) is a momentum oscillator used by traders to identify overbought and oversold areas from where a pullback or price reversal can be expected
• An asset is usually considered overbought when the RSI is above 70% and oversold when it is below 30%
• Overbought areas, even as high as 85, and oversold areas as low as 15 can persist for long periods of time, so it is important to use other technicals in coming to a decision as to when price might be about to reverse
• The RSI is commonly used to spot divergence in the market, when price is moving in the opposite direction of momentum at the overbought and oversold zones
• It’s important to remember that the RSI will often provide signals before the information is reflected in the chart.

Seeking information on how to double-check signals with various indicators? Check out the Indicators & Oscillator section available in our learning section. You may also want to explore our other educational material such as our free webinars, workshops and how-to videos. Once you’ve opened an account, live or demo, you can put your knowledge into practice.

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