What is RSI Indicator? Relative Strength Index Explained

Our goal is to deliver the most understandable and comprehensive explanations of financial topics using simple writing complemented by helpful graphics and animation videos. The mid-line at 50 can provide additional insights into the market’s momentum. The RSI value is obtained by normalizing the RS to a scale of 0-100, with 100 indicating the strongest possible upward momentum and 0 signifying the strongest possible downward momentum.

Again, the higher high is usually just below overbought levels in the area. Chart 12 shows Starbucks (SBUX) forming a lower high as RSI forms a higher high. Even though RSI forged a new high and momentum was strong, the price action failed to confirm as lower high formed. This negative reversal foreshadowed the big support break in late June and sharp decline. Like many momentum oscillators, overbought and oversold readings for RSI work best when prices move sideways within a range.

Plotting RSI

Here we will also take a look at three scenarios, indicating trend reversal or confirmation signals. They are observed during upward market movements where the RSI indicates potential selling pressure. This is another trend reversal signal that occurs when the RSI and the price divert from each other. This happens when the price makes a lower low while the RSI marks a higher low. Depending on the number of times this event repeats, the trader can forecast the strength of the forming signal (the more, the better for the bulls). This comes to show that it is imperative to look at both – the RSI and the price movement.

The same idea applies to a security that technical indicators such as the relative strength index highlight as oversold. Traders watching for just such an indication might expect a price correction or trend reversal and buy the security. Overbought refers to a security that trades at a price relative strength index definition level above its true (or intrinsic) value. That means that it’s priced above where it should be, according to practitioners of either technical analysis or fundamental analysis. Traders who see indications that a security is overbought may expect a price correction or trend reversal.

RSI in Combination with Other Indicators

Last but certainly not least, RSI helps traders determine and confirm general trends. By trading in the direction of the trend, you can make more money. RSI can show patterns the underlying price chart cannot, like https://www.bigshotrading.info/ double tops and bottoms as well as support and resistance, that predict price changes further ahead. RSI also help traders identify divergences, which is when the RSI reading does not match an asset’s movement.

Don’t apply the RSI to a limited period like a trading day, for example. Doing so may skew your analysis, which will lead to making losing trading decisions. Traders usually apply the RSI on timetables of 14 periods (some use the RSI in periods ranging from 2 to up to 25 intervals). Bear in mind that, while a longer time frame won’t affect your analysis negatively, a shorter one will. The indicator is applied by technical traders, specialized in trading a wide variety of asset classes, including stocks, FX, futures, etc.

Computing Average Gains and Losses

Relating the result of this comparison to price action can give traders an idea of how a security may perform. The RSI, used in conjunction with other technical indicators, can help traders make better-informed trading decisions. Opposite to the bullish divergence signal, the bearish one is observed when the RSI marks a lower high, and the price marks a higher high.

• Similarly, an overbought reading during a downtrend is much lower than 70.
• Wilder’s formula normalizes RS and turns it into an oscillator that fluctuates between zero and 100.
• It is basically a move to oversold levels and then a higher low above oversold levels.
• Cardwell considered bearish divergences to be bull market phenomena.
• The remaining seven days all closed lower with an initial average loss of −0.8%.

As a momentum indicator, the trend lines are much more reliable in the macro than in the micro. It’s difficult to see trend reversals, sell signs or overbought levels accurately in short time periods. The Relative Strength Index is a technical momentum indicator.