What is RSI?
The Relative Strength Index, developed by J. Welles Wilder Jr. in 1978, is a momentum oscillator ranging from 0 to 100. It is calculated as RSI = 100 - (100 / (1 + RS)), where RS is the average gain over the past 14 periods divided by the average loss. Readings above 70 traditionally indicate overbought conditions, while readings below 30 suggest oversold conditions. RSI is one of the most widely used technical indicators, appearing on virtually every charting platform.
Practical Trading Applications
Beyond simple overbought/oversold signals, traders watch for RSI divergences: when price makes a new high but RSI does not, it suggests weakening momentum and a potential reversal. Failure swings, where RSI crosses above 30 after being oversold or drops below 70 after being overbought, provide more reliable entry signals than raw threshold crossings. In strong trends, RSI can remain overbought or oversold for extended periods, so many practitioners adjust thresholds to 80/20 in trending markets and 70/30 in ranging markets.
Key Considerations
RSI works best as a confirmation tool rather than a standalone signal generator. Backtesting studies show that RSI-based strategies produce modest returns before transaction costs and often underperform buy-and-hold after costs. Combining RSI with trend-following indicators like moving averages or with volume confirmation significantly improves signal quality. The default 14-period lookback can be shortened to 7 for more sensitive signals or lengthened to 21 for smoother readings, depending on the trading timeframe.