The Relative Strength Index (RSI) is one of the most widely used momentum indicators in trading. Understanding how to use it correctly can help you identify potential reversal points and confirm trends.
What Is RSI?
The RSI is a momentum oscillator that measures the speed and magnitude of recent price changes. It oscillates between 0 and 100.
Created by: J. Welles Wilder Jr. in 1978
Default period: 14 (can be adjusted)
Formula: RSI = 100 – [100 / (1 + RS)] Where RS = Average Gain / Average Loss over the period
How to Read RSI
The Basics
- RSI above 70: Traditionally considered overbought
- RSI below 30: Traditionally considered oversold
- RSI around 50: Neutral zone
What "Overbought" Actually Means
Contrary to what many beginners think, overbought doesn't mean "sell now."
Overbought means strong upward momentum. In strong trends, RSI can remain overbought for extended periods. Selling just because RSI hit 70 often means selling too early in a trending market.
What "Oversold" Actually Means
Similarly, oversold doesn't mean "buy now."
A stock in a strong downtrend can stay oversold for days or weeks. Buying just because RSI hit 30 can result in catching a falling knife.
Effective RSI Strategies
Strategy 1: Divergence
Divergence is often the most reliable RSI signal.
Bullish Divergence:
- Price makes a lower low
- RSI makes a higher low
- Suggests downward momentum is weakening
Bearish Divergence:
- Price makes a higher high
- RSI makes a lower high
- Suggests upward momentum is weakening
Divergence doesn't guarantee a reversal, but it warns that the current trend may be losing steam.
Strategy 2: RSI with Trend
Use RSI differently depending on the trend:
In uptrends:
- RSI tends to oscillate between 40 and 80
- "Oversold" is closer to 40-50 (not 30)
- Buy pullbacks when RSI reaches 40-50 range
In downtrends:
- RSI tends to oscillate between 20 and 60
- "Overbought" is closer to 50-60 (not 70)
- Sell rallies when RSI reaches 50-60 range
Strategy 3: RSI Trendlines
You can draw trendlines on the RSI itself:
- A break of an RSI trendline can precede a price breakout
- Often provides earlier signals than price trendlines
Strategy 4: Failure Swings
A failure swing occurs when RSI doesn't reach the expected extreme before reversing:
Bullish failure swing:
- RSI falls below 30
- Bounces above 30
- Pulls back but stays above 30
- Breaks above its recent high
= Bullish signal
Bearish failure swing:
- RSI rises above 70
- Falls below 70
- Rallies but stays below 70
- Breaks below its recent low
= Bearish signal
Common RSI Mistakes
Mistake 1: Using RSI as a Standalone Signal
RSI should confirm other analysis, not replace it. Combine with:
- Price action and patterns
- Support and resistance
- Volume analysis
- Trend direction
Mistake 2: Ignoring the Trend
In strong trends, RSI extremes mean less. Respect the primary trend.
Mistake 3: Using Only Default Settings
The 14-period setting isn't sacred. Some traders prefer:
- 9 periods for more sensitivity
- 21 periods for smoother signals
Test what works for your trading style.
Mistake 4: Expecting Immediate Reversals
Just because RSI is oversold doesn't mean price will reverse immediately. It can stay oversold while trending down.
Multi-Timeframe RSI
For stronger signals, check RSI across timeframes:
- Daily RSI oversold + weekly RSI starting to turn up = stronger buy signal
- Daily RSI overbought + weekly RSI overbought = potential major top
Practice RSI Analysis
At ChartMini, you can practice identifying RSI signals and divergences on historical charts. See how price acted after various RSI signals—which ones worked and which failed.
This practice builds intuition for when RSI signals are most reliable.
Conclusion
RSI is a powerful tool when used correctly, but it's not a crystal ball. The most effective approach is to:
- Understand the trend context
- Look for divergences
- Combine with price action
- Wait for confirmation
Master these principles, and RSI will become a valuable part of your trading toolkit.