Relative Strength Index (RSI)
Quick Definition
A momentum indicator measuring the speed and magnitude of price changes on a 0-100 scale, used to identify overbought or oversold conditions.
What Is Relative Strength Index (RSI)?
The Relative Strength Index (RSI) is a momentum oscillator that measures the speed and magnitude of recent price changes to evaluate overbought or oversold conditions. Developed by J. Welles Wilder Jr. in 1978.
How RSI Works:
- Scale: 0 to 100
- Overbought: RSI above 70 (potential sell signal)
- Oversold: RSI below 30 (potential buy signal)
- Neutral: RSI between 30-70
Formula: RSI = 100 - [100 / (1 + RS)] Where RS = Average Gain / Average Loss (over 14 periods typically)
Trading Signals:
- Divergence: Price makes new high but RSI doesn't → potential reversal
- Centerline Crossover: RSI crossing 50 can confirm trend direction
- Failure Swings: RSI fails to reach previous extreme → trend weakening
Limitations:
- Can stay overbought/oversold for extended periods in strong trends
- Works best in ranging markets
- Should be used with other indicators for confirmation
- Different timeframes can show conflicting signals
Best Practices:
- Use 14-period RSI as standard
- Combine with price action analysis
- Look for divergences as early warning signs
- Adjust overbought/oversold levels for trending markets (80/20)
Formula
Formula
RSI = 100 - [100 / (1 + RS)]Relative Strength Index (RSI) Example
- 1RSI at 75 on AAPL suggests stock may be overbought
- 2RSI dropping below 30 during a selloff may signal buying opportunity
Related Terms
Moving Average Convergence Divergence (MACD)
A trend-following momentum indicator showing the relationship between two moving averages of a security's price.
Moving Average
A calculation that averages a security's price over a specific number of periods, smoothing price data to identify trends.
Support Level
A price level where buying pressure typically overcomes selling pressure, preventing further decline.
Bollinger Bands
A volatility indicator consisting of a middle moving average and two bands that expand and contract based on price volatility.
Support and Resistance
Key price levels where buying pressure (support) prevents further decline or selling pressure (resistance) prevents further advance.
Candlestick Chart
A chart type showing open, high, low, and close prices for each period, with color-coded bodies indicating direction.
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