Relative Strength Index (RSI): Formula, Uses & Strategy

The Relative Strength Index (RSI Indicator) is one of the most widely used technical tools for measuring momentum in financial markets. Acting as an oscillator between 0 and 100, RSI helps traders determine whether a stock is overbought (above 70) or oversold (below 30).

By properly employing the RSI Indicator strategy, traders can identify potential trend reversals, refine their entry and exit points, and improve risk management.

This guide covers everything about RSI—its formula, usage, interpretation, divergences, reversals, swing rejections, and limitations—to help you trade more effectively.

RSI Formula: How to Calculate Step by Step

Formula:

RSI=100−(1001+RS)RSI = 100 – \left( \frac{100}{1 + RS} \right)RSI=100−(1+RS100​)

Where:

• RS = Average Gain ÷ Average Loss (over the chosen period, usually 14 days).

Edge cases:

• If Avg Loss = 0 ⇒ RSI = 100

• If Avg Gain = 0 ⇒ RSI = 0

• If both = 0 ⇒ RSI = 50 (no price change)

Step-by-step calculation

1. Choose period (n): Typically 14 days.

2. Calculate price changes: Close(today) – Close(yesterday).

3. Separate gains & losses:

   • Gain = max(Change, 0)

   • Loss = max(−Change, 0)

4. Find averages:

   • Avg Gain = Sum of gains ÷ n

   • Avg Loss = Sum of losses ÷ n

5. Compute RS and RSI:

   • RS = Avg Gain ÷ Avg Loss

   • RSI = 100 − (100 ÷ (1 + RS))

6. Smooth with Wilder’s formula for rolling periods.

Quick Example (n=5):

• Prices: 100, 102, 101, 103, 105, 104

• Changes: +2, −1, +2, +2, −1

• Avg Gain = 1.20, Avg Loss = 0.40

• RS = 3 → RSI = 75

How to Implement RSI

Most trading platforms (TradingView, Zerodha, MetaTrader) compute RSI automatically.

Steps to use RSI effectively:

1. Add RSI with default 14-period setting.

2. Interpret levels:

   • Above 70 = Overbought

   • Below 30 = Oversold

   • Around 50 = Neutral zone

3. Use RSI signals:

   • Overbought/Oversold → potential reversal.

   • Divergence with price → possible trend change.

   • 50-line crossover → confirms bullish/bearish bias.

4. Confirm with other indicators (moving averages, volume, support–resistance).

Why Is RSI Important?

• Measures momentum strength quickly.

• Identifies overbought/oversold conditions.

• Helps time entries and exits better.

• Applicable across all assets: stocks, commodities, forex.

• Useful for both trend-following and reversal strategies.

Using RSI with Trends

RSI becomes more reliable when combined with trend direction:

• Uptrend: RSI usually ranges between 40–80. Dips to 40–50 often signal buying opportunities.

• Downtrend: RSI tends to stay between 20–60. Rebounds near 50–60 are often selling opportunities.

Bullish vs Bearish RSI Numbers

• Bullish RSI: Above 50 (strong buyers). Between 50–70 = bullish zone; above 70 = overbought but still bullish.

• Bearish RSI: Below 50 (sellers dominate). Between 30–50 = bearish; below 30 = oversold.

Interpretation of RSI Ranges

RSI Divergences

Divergence occurs when price and RSI move in opposite directions, signaling a potential reversal.

• Bullish Divergence: Price makes a lower low, RSI makes a higher low → Downtrend weakening.

• Bearish Divergence: Price makes a higher high, RSI makes a lower high → Uptrend weakening.

Why it matters: Divergences often precede price reversals, giving early warning signals.

RSI Reversals

Unlike divergences, RSI reversals confirm continuation trends.

1. Positive Reversal (Bullish): Price makes a higher low, RSI makes a lower low → trend likely to continue upward.

2. Negative Reversal (Bearish): Price makes a lower high, RSI makes a higher high → trend likely to continue downward.

RSI Swing Rejections

A swing rejection occurs when RSI enters an overbought/oversold zone and quickly reverses.

• Bullish Swing Rejection: RSI falls below 30, rebounds above it, confirming a possible bottom.

• Bearish Swing Rejection: RSI rises above 70, then falls back below it, signaling a top.

RSI vs MACD

• RSI: Measures momentum relative to price changes.

• MACD: Focuses on moving averages and convergence/divergence.

• Traders often use both together for confirmation.

Limitations of RSI

• False signals in strong trends (RSI may stay overbought/oversold for long).

• Works best with trend confirmation tools.

• Requires context (support–resistance, volume analysis).

Common Questions

What is a good RSI number?

• RSI around 50 = neutral.

• Use 30/70 thresholds for reversals.

Should I buy when RSI is low?

• RSI below 30 signals oversold, but confirm with trend and volume before buying.

What happens when RSI is high?

• RSI above 70 signals overbought, often followed by corrections.

Conclusion

The Relative Strength Index (RSI Indicator) remains one of the most effective tools in technical analysis. With its clear signals of overbought, oversold, divergences, and reversals, RSI helps traders make informed entry and exit decisions.

When combined with trend analysis, support–resistance, and volume indicators, the RSI Indicator strategy can significantly enhance trading performance.

However, like all indicators, RSI should not be used in isolation—it works best as part of a comprehensive trading system.

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