The Relative Strength Index (RSI), developed by J. Welles Wilder Jr., measures the speed and size of recent price changes on a scale from 0 to 100.
How RSI is calculated
RSI = 100 − 100 ÷ (1 + RS), where RS is the average gain divided by the average loss over the lookback period (14 by default), using Wilder’s smoothing.
When gains dominate, RSI rises toward 100; when losses dominate, it falls toward 0.
Three ways to trade RSI
1. Overbought and oversold
Readings above 70 are considered overbought and below 30 oversold. On their own these are weak signals — in a strong uptrend RSI can stay above 70 for weeks. Use them only in ranging markets, and wait for RSI to cross back inside the band before acting.
2. Divergence
A bullish divergence occurs when price makes a lower low but RSI makes a higher low — selling momentum is fading. A bearish divergence is the opposite. Divergences work best at key levels and combined with a structure break such as the 1-2-3 reversal.
3. Trend ranges
In uptrends, RSI tends to oscillate between roughly 40 and 80; in downtrends, between 20 and 60. A pullback that holds RSI near 40 in an uptrend can be a buying opportunity — and RSI failing to hold 40 is an early warning that the trend is changing.
A worked calculation
Suppose over the last 14 periods the smoothed average gain is 0.60 and the average loss is 0.40.
- RS = 0.60 ÷ 0.40 = 1.5
- RSI = 100 − 100 ÷ (1 + 1.5) = 100 − 40 = 60
Gains are outweighing losses, but not by enough to be overbought.
Settings at a glance
| Period | Levels | Use |
|---|---|---|
| 14 | 70 / 30 | The standard for most markets |
| 14 | 80 / 20 | Strong trends — fewer premature signals |
| 7–9 | 70 / 30 | Short-term trading, more signals |
| 2 | 90 / 10 | Short-term mean reversion on stocks and indices |
Example: the trend-range pullback
A stock is in an uptrend above its rising 50-day average, and RSI has been oscillating between about 40 and 80. A pullback drags RSI to 41, where it holds, and the next day closes above the prior day’s high.
- Entry: $57.20
- Stop: below the pullback low at $55.60 — $1.60 of risk per share
- Target: 2R, $57.20 + $3.20 = $60.40
- Size: risking $200, the position is 125 shares
If RSI had instead fallen through 40 and kept going, the uptrend’s momentum range would have broken — a reason to stand aside.
Common mistakes
- Shorting every reading above 70 in a strong trend.
- Treating divergence as an entry signal without price confirmation.
- Over-optimizing the period to fit past data.
Frequently asked questions
What are the best RSI settings?
The default 14-period RSI with 70/30 levels suits most traders. Shorter periods (7–9) give more signals but more noise; in strong trends, 80/20 levels filter out premature reversal signals.
Is RSI a leading or lagging indicator?
RSI is calculated from past prices, so it lags. Divergences can, however, warn of weakening momentum before price turns.
What does an RSI of 50 mean?
An RSI of 50 means average gains and losses over the lookback period are equal. Many traders use 50 as a simple trend filter: above 50 favors longs, below 50 favors shorts.
What is hidden divergence?
Hidden bullish divergence is when price makes a higher low but RSI makes a lower low, often seen during pullbacks in uptrends. It suggests the trend is likely to continue rather than reverse.
What timeframe is best for RSI?
RSI works on every timeframe. Divergence and trend-range signals are generally more reliable on the 1-hour, 4-hour and daily charts than on 1- to 5-minute charts.