Relative Strength Index (RSI)

The Relative Strength Index (RSI) is calculated by comparing average price gains against average losses over a specified period, typically 14 periods, using the formula: RSI = 100 - (100 / (1 + RS)), where RS is the average gain divided by the average loss during that lookback window. The indicator's value always ranges between 0 and 100.

Traditionally, the area above 70 is considered overbought territory, signaling a potential pullback or bearish reversal, while the area below 30 is considered oversold, hinting at a possible bullish bounce. The 50 level also serves as a baseline, indicating buyer dominance when price is above it and seller control when below it.

One of the most vital applications of the RSI is identifying divergences. A bearish divergence occurs when the price prints a higher high while the RSI forms a lower high, indicating waning upside momentum despite continued price gains; the opposite is true for a bullish divergence. These divergences act as an early warning signal of a potential trend reversal.

A common mistake is treating an indicator's entry into overbought or oversold zones as an immediate signal to enter a counter-trend trade, whereas price can remain overextended within these extreme zones for prolonged periods, especially in strong trends. Therefore, it is best to combine the RSI with broader trend analysis and key support and resistance levels rather than trading it in isolation.