Relative Strength Index (RSI): Calculation, Uses

The Relative Strength Index (RSI) is a popular momentum oscillator used by traders to measure the speed and change of price movements. Developed by J. Welles Wilder, the RSI is a versatile indicator that can be applied to various financial assets, including stocks, bonds, commodities, and cryptocurrencies. It provides traders with valuable insights into overbought and oversold conditions, helping them make more informed trading decisions.

The RSI is calculated using a straightforward formula:

RSI = 100 – [100 / (1 + RS)]

Where:

• RS (Relative Strength) = Average Gain over a period / Average Loss over a period
• The default period used is 14 days, though traders may adjust it based on their strategy.

To break it down further:

1. Calculate the average gain and average loss over the chosen period.
2. Divide the average gain by the average loss to determine Relative Strength (RS).
3. Plug RS into the RSI formula to get the final value.

Let’s assume the closing prices of a stock over 14 days:

Calculate Average Gain and Average Loss:

• Total gains = 16 → Average Gain = 16 / 14 = 1.14
• Total losses = 4 → Average Loss = 4 / 14 = 0.29

Determine RS (Relative Strength):

RS = 1.14 / 0.29 = 3.93

Calculate RSI:

RSI = 100 − (100 / (1+3.93)) = 79.7

Since the RSI is above 70, this suggests the stock is in overbought territory, indicating a potential pullback.

The RSI is a versatile tool that traders use to identify potential trend reversals and confirm existing trends. Here are some common applications:

Overbought and Oversold Conditions: When the RSI reaches 70 or above, it suggests that an asset may be overbought and due for a potential reversal. Conversely, an RSI value of 30 or below may indicate an oversold condition, signaling a potential buying opportunity.

Divergence Analysis: Traders often use RSI to identify divergence between the RSI and the price of an asset. Divergence can be a signal that a trend is weakening and may reverse.

Confirmation of Trends: Traders can use the RSI to confirm the strength of an existing trend. When the RSI moves in the same direction as the price, it confirms the trend’s strength.

Signals Potential Trend Reversals: Divergences between RSI and price movements suggest that momentum is weakening, possibly leading to a trend reversal.

Enhances Risk Management: RSI helps traders fine-tune entry and exit points, reducing the risk of buying at market peaks or selling at bottoms.

Works Across Multiple Asset Classes: Whether trading stocks, forex, commodities, or crypto, RSI is widely applicable and enhances decision-making in diverse markets.

Interpreting RSI requires an understanding of overbought and oversold levels, divergences, and trend confirmation.

• When RSI exceeds 70, the asset is considered overbought, suggesting it may experience a pullback or correction.
• High RSI alone is not a sell signal but should be combined with other indicators like volume analysis.

• When RSI falls below 30, the asset is oversold, indicating a potential price rebound.
• This is often seen as a buying opportunity, especially when combined with support levels.

• Bullish Divergence: Price makes lower lows, but RSI makes higher lows → Potential upward reversal.
• Bearish Divergence: Price makes higher highs, but RSI makes lower highs → Potential downward reversal.

• Above 50 → Signals an uptrend (bullish momentum).
• Below 50 → Indicates a downtrend (bearish momentum).

A “good” RSI depends on the asset, market conditions, and trader strategy.

• For Trending Markets: RSI above 50 in an uptrend and below 50 in a downtrend is considered strong.
• For Swing Trading: RSI levels between 40-60 indicate consolidation, while moves above 70 or below 30 suggest potential breakouts.
• For Mean Reversion Trading: Buying near 30 RSI and selling near 70 RSI works well in range-bound markets.

Despite its usefulness, RSI has some limitations that traders should consider.

False Signals: RSI can generate false signals, especially in ranging markets or during extended trends. Traders should be cautious and not rely solely on RSI for decision-making.

Lagging Indicator: RSI is a lagging indicator, meaning it reflects past price action. It may not provide timely signals in rapidly changing markets.

Whipsaws: RSI signals can sometimes result in whipsaws, where the price reverses shortly after a signal is generated. This can lead to losses for traders who act on these signals without confirmation from other indicators or analysis.

Subjectivity: RSI interpretation can be subjective. Different traders may have different criteria for what constitutes overbought or oversold conditions or how they interpret divergence patterns.

Not Suitable for All Markets: RSI is most effective in trending markets. In choppy or sideways markets, it may produce many false signals, making it less useful.

No Information on Magnitude: RSI does not provide information about the magnitude of price changes. It only indicates the relative strength of recent price movements.

Not a Standalone Indicator: RSI is best used in conjunction with other technical indicators, chart patterns, and fundamental analysis for a comprehensive trading or investing strategy.

RSI values are available within the InvestingPro platform, along with an analysis of performance and RSI competitor benchmark data.

For example, see below the RSI values* for Apple (AAPL):

Yes, the RSI is a versatile indicator suitable for analyzing various financial assets, including stocks, bonds, commodities, and cryptocurrencies.

While there’s no one-size-fits-all answer, an RSI value above 70 may indicate an overbought condition, potentially signaling a selling opportunity. Conversely, an RSI below 30 may suggest an oversold condition, potentially indicating a buying opportunity.

The RSI focuses on momentum and is particularly effective in identifying overbought and oversold conditions. It complements other technical indicators, such as moving averages and MACD, which provide different types of information.

While the RSI is a valuable tool, it is typically used in conjunction with other indicators and analysis techniques to make well-informed trading decisions.

Yes, but it’s more effective for short- to medium-term trading. Long-term investors should combine RSI with fundamental analysis.