What you will learn
- Explain what the RSI measures and its 0 to 100 range
- Calculate the RSI from average gains and average losses
- Interpret overbought and oversold readings correctly
- Avoid the classic mistake of mechanically fading a strong trend
The relative strength index, or RSI, is one of the most popular momentum indicators ever devised, created by J. Welles Wilder. Where the MACD measures momentum through moving averages, the RSI measures it as a single number bounded between zero and one hundred, which makes it easy to read and to compare across time.
RSI indicator cheat sheet (Rayner Teo)
A reputable educator on reading the RSI, the overbought and oversold zones, and the 50 level. Watch before the calculation below.
What it measures
The RSI gauges the speed and size of recent price changes by comparing the average size of recent gains to the average size of recent losses. When recent gains dominate, the RSI rises toward one hundred. When recent losses dominate, it falls toward zero. The standard calculation uses a fourteen-period window. The result is a smooth oscillator that rises and falls with the momentum of price.
Key terms
- RSI
- A momentum oscillator from 0 to 100 comparing a security's own recent gains to its own recent losses.
- Relative strength (RS)
- The average gain divided by the average loss over the window. The RSI is built from it.
- Overbought
- An RSI above 70, meaning price has risen fast and may pause. Not an automatic sell.
- Oversold
- An RSI below 30, meaning price has fallen fast and may bounce. Not an automatic buy.
Calculating the RSI
Over the last 14 periods, a stock's average gain was 2 and its average loss was 1. What is its RSI? The formula is RSI equals 100 minus 100 divided by (1 plus RS), where RS is the average gain divided by the average loss.
- Find the relative strength, RS. Average gain divided by average loss: 2 divided by 1 is 2.
- Plug into the formula. RSI equals 100 minus 100 divided by (1 plus 2), which is 100 minus 100 divided by 3.
- Solve. 100 divided by 3 is about 33.3, so 100 minus 33.3 is about 66.7.
Why it matters: The RSI just turns the balance of recent gains versus losses into a single number from 0 to 100. More gains push it up, more losses push it down.
Calculate the RSI
Over the window, a stock's average gain was 3 and its average loss was 1. Using RSI equals 100 minus 100 divided by (1 plus RS), what is its RSI? Round to the nearest whole number.
A common point of confusion
Despite its name, the relative strength index does not measure a stock's strength relative to other stocks or to the market. It measures the relationship between a security's own recent gains and its own recent losses. Confusing it with relative-strength comparisons between different assets is a frequent beginner error worth avoiding from the start.
Overbought and oversold
- An RSI reading above seventy is traditionally considered overbought, meaning price has risen quickly and may be due for a pause or pullback.
- An RSI reading below thirty is traditionally considered oversold, meaning price has fallen quickly and may be due for a bounce.
- These thresholds are conventions, not magic numbers, and they describe momentum, not a guaranteed turning point.
The crucial caveat
Here is a mistake that costs inexperienced traders. Overbought does not mean sell, and oversold does not mean buy. In a strong trend, an asset can remain overbought for a long time while it keeps climbing, and oversold while it keeps falling. Acting mechanically on the seventy and thirty thresholds, especially against a strong trend, is a classic way to lose money. The RSI describes momentum conditions. It does not dictate action on its own.
Overbought is not a sell signal. A strong trend can stay overbought far longer than an impatient trader can stay solvent betting against it.
Most traders use RSI completely wrong (Mind Math Money)
A clear explainer of the RSI and the common misreadings of overbought and oversold. Watch for why fading a strong trend on RSI is dangerous.
The RSI says overbought
A stock is in a powerful uptrend and its RSI has been sitting above 70 for two weeks while the price keeps climbing. A beginner shorts it because overbought means sell. What is wrong with that reasoning?
Overbought is not a sell signal. In a strong uptrend the RSI can stay above 70 for a long time while price climbs, so mechanically shorting it fights the trend and usually loses.Divergence and proper use
As with the MACD, divergence is one of the RSI's most respected signals. If price makes a new high but the RSI makes a lower high, that bearish divergence hints that momentum is weakening beneath a rising price. Bullish divergence is the reverse during a decline. Used well, the RSI is a momentum context tool, best combined with the trend, support and resistance, and other evidence, rather than treated as a standalone buy-and-sell machine. The honesty of the first lesson applies here too: it shifts odds, it does not guarantee outcomes.
Clear up the name
The name relative strength index misleads many beginners. Explain in a sentence or two what the RSI actually compares, and what it does not compare.
Write an answer before comparing it with the model response.
Model answer
The RSI compares a security's own recent average gains to its own recent average losses, turning that balance into a number from 0 to 100. It does not compare the stock's strength to other stocks or to the market, despite the word relative in its name. It is a self-contained momentum reading of one security, not a ranking of one asset against another.
The RSI reads momentum as a single number. The next indicator, Bollinger Bands, adds a different dimension, wrapping price in an envelope that measures volatility.