Relative Strength Index (RSI)
By WikiWealth Editorial Team|Last updated:
Key Takeaways
- RSI is a momentum oscillator that ranges from 0 to 100
- Readings above 70 indicate overbought conditions; below 30 indicate oversold conditions
- RSI is calculated using average gains and losses over a 14-period default lookback
- Divergences between RSI and price can signal potential trend reversals
Definition
The Relative Strength Index (RSI) is a momentum oscillator developed by J. Welles Wilder Jr. that measures the speed and magnitude of recent price changes to evaluate whether a security is overbought or oversold. RSI values range from 0 to 100, with readings above 70 traditionally indicating overbought conditions and readings below 30 indicating oversold conditions. It is one of the most widely used technical indicators alongside moving averages.
How It Works
RSI is calculated using the formula: RSI = 100 − (100 ÷ (1 + RS)), where RS (Relative Strength) = Average Gain over N periods ÷ Average Loss over N periods. The default period is 14 (trading days for daily charts). After the initial calculation, subsequent values use a smoothing method that weights recent data more heavily. An RSI of 70+ suggests a security has been aggressively bought and may be due for a pullback. An RSI below 30 suggests heavy selling and a possible bounce. Traders also watch for divergences — when price makes a new high but RSI does not (bearish divergence) or price makes a new low but RSI does not (bullish divergence) — as potential reversal signals.
Example
A trader monitoring Tesla (TSLA) sees the stock rally from $180 to $280 over three weeks, pushing the 14-day RSI from 55 to 82. The RSI above 70 suggests overbought conditions, but the trader notes that in strong uptrends, RSI can remain above 70 for extended periods. When the stock reaches $300 but RSI only reaches 78 (a lower high than the previous 82), this bearish divergence suggests the upward momentum is fading. The trader tightens their stop-loss order to protect profits.
Why It Matters
RSI helps traders quantify momentum and identify potential turning points in price trends. It is particularly useful for timing entries and exits, managing risk, and confirming signals from other indicators. While no single indicator is reliable in isolation, RSI's simplicity and effectiveness have made it a standard component of most traders' technical analysis toolkits. It works across all timeframes and asset classes, from day trading stocks to analyzing long-term cryptocurrency trends.
Advantages
- Simple, bounded indicator (0 to 100) that is easy to interpret
- Effective at identifying potential overbought and oversold conditions
- Divergences can provide early warning of trend reversals
- Works across all timeframes and asset classes
Limitations
- Can remain overbought or oversold for extended periods during strong trends
- False signals are common in choppy or range-bound markets
- The default 14-period setting may not be optimal for all securities or timeframes
- Should be used in conjunction with other analysis tools, not as a standalone signal
Frequently Asked Questions
Related Terms
Browse more definitions in the financial terms glossary.