What Is RSI in Stocks?
The Relative Strength Index (RSI) is a technical analysis indicator that measures the speed and magnitude of price movements. It was developed in 1978 by J. Welles Wilder Jr. in his book New Concepts in Technical Trading Systems.
RSI is a momentum oscillator displayed as a line graph ranging from 0 to 100. A high RSI signals that a stock might be overbought, whereas a low RSI indicates that it might be oversold. This makes RSI one of the most trusted tools for traders seeking to time entries and exits.
RSI Formula
RSI is calculated using average gains and losses over a specific period, typically 14 trading days.
Step 1: Calculate the Relative Strength (RS) RS=Average Gain over 14 periodsAverage Loss over 14 periodsRS = \frac{\text{Average Gain over 14 periods}}{\text{Average Loss over 14 periods}}RS=Average Loss over 14 periodsAverage Gain over 14 periods
Step 2: Calculate RSI RSI=100−1001+RSRSI = 100 – \frac{100}{1 + RS}RSI=100−1+RS100
Example:
If the average gain over 14 days is 1.5% and the average loss is 1%, RS=1.51=1.5RS = \frac{1.5}{1} = 1.5RS=11.5=1.5 RSI=100−1001+1.5=100−1002.5=60RSI = 100 – \frac{100}{1 + 1.5} = 100 – \frac{100}{2.5} = 60RSI=100−1+1.5100=100−2.5100=60
This RSI value indicates moderately strong bullish momentum.
How to Use RSI in Stock Trading
1. Identify Overbought and Oversold Conditions
- Overbought (RSI > 70): Stock may be overvalued and prone to a price drop.
- Oversold (RSI < 30): Stock may be undervalued and poised for a rebound.
2. Recognize Trend Strength
RSI can confirm trends:
- In an uptrend, RSI often remains above 30 and frequently reaches 70+.
- In a downtrend, RSI stays below 70 and often hits 30 or lower.
3. Spot Divergences
RSI Divergence occurs when the price moves in one direction but RSI moves in the opposite.
- Bullish Divergence: Price makes lower lows, RSI makes higher lows → potential upward reversal.
- Bearish Divergence: Price makes higher highs, RSI makes lower highs → potential downward reversal.
4. Use RSI Swing Rejections
Swing rejection signals give precise entry points:
- Bullish Swing Rejection: RSI dips below 30, crosses above it, forms higher lows, and breaks its previous high.
- Bearish Swing Rejection: RSI rises above 70, crosses below it, forms lower highs, and breaks its previous low.
RSI for Different Trading Styles
| Trading Style | RSI Period | Strategy Tip |
|---|---|---|
| Day Trading | 5–9 | Capture short-term momentum swings. Use small stop losses. |
| Swing Trading | 14 | Default setting; works well for 1–2 week trades. |
| Long-Term Investing | 21–30 | Smooths out noise; useful for position trading and trend confirmation. |
RSI vs Other Indicators
- RSI vs MACD: MACD tracks the relationship between moving averages; RSI measures momentum based on price changes. Using both provides a fuller picture.
- RSI vs Stochastic Oscillator: Stochastic also identifies overbought/oversold levels but reacts faster to price changes. Combining both can reduce false signals.
Practical RSI Tips for Traders
- Confirm with Trend: Don’t rely solely on RSI; check moving averages or trendlines.
- Adjust Levels in Strong Trends: In strong uptrends, RSI below 40 can still be bullish; in downtrends, RSI above 60 may remain bearish.
- Combine with Price Patterns: Look for double tops, double bottoms, and support/resistance along with RSI signals.
- Backtest Strategies: Before live trading, test RSI signals on historical data to validate performance.
- Beware of False Signals: RSI can remain overbought or oversold for extended periods in strong trends.
Limitations of RSI
- Can generate false buy/sell signals in strong trending markets.
- Overbought ≠ sell immediately, oversold ≠ buy immediately. Context matters.
- Should always be used with complementary indicators for reliable trading decisions.
Example of RSI in Action
- Scenario 1: Stock ABC RSI drops to 25 → oversold → combined with a bullish candlestick pattern → potential buy signal.
- Scenario 2: Stock XYZ RSI rises to 75 → overbought → price fails to break resistance → potential sell signal.
Conclusion
The stocks RSI indicator is a powerful tool for identifying momentum, spotting overbought/oversold conditions, and predicting potential trend reversals. Whether you are a day trader, swing trader, or long-term investor, understanding RSI’s calculations, signals, and limitations is essential for smarter trading decisions.
By combining RSI with other indicators, trends, and market context, traders can gain a competitive edge in spotting opportunities while minimizing risks.
Bottom Line: RSI isn’t just a number; it’s a momentum compass. Use it wisely, combine with other tools, and it can help you navigate the stock market with confidence.
