The Relative Strength Index (RSI) describes a momentum indicator that measures the magnitude of recent price changes in order to evaluate overbought or oversold conditions in the price of a stock or other asset. Originally developed by noted American technical analyst J. Welles Wilder Jr., who introduced the concept in his seminal 1978 book, "New Concepts in Technical Trading Systems," the RSI is displayed as an oscillator, which is a line graph that moves between two extremes. Its reading can range from 0 to 100.
The primary trend of the stock or asset is an important tool used to ensure that the indicator's readings are properly understood. Well-known market technician Constance Brown has widely promoted the idea that an oversold reading on the RSI that occurs in an uptrend is likely much higher than 30%, and an overbought reading on the RSI that occurs during a downtrend is much lower than 70%.
Traditional interpretation and usage of the RSI dictates that values of 70 or above suggest that a security is becoming overbought or overvalued and may be primed for a trend reversal or corrective price pullback. An RSI reading of 30 or below indicates an oversold or undervalued condition.
- In finance, the Relative Strength Index (RSI) is a type of momentum indicator that looks at the pace of recent price changes so as to determine whether a stock is ripe for a rally or a selloff.
- The RSI is used by market statisticians and traders, in addition to other technical indicators as a means of identifying opportunities to enter or exit a position.
- Generally, when the RSI surpasses the horizontal 30 reference level, it is a bullish sign and when it slides below the horizontal 70 reference level, it is a bearish sign.
Overbought and Oversold Levels
In terms of market analysis and trading signals, when the RSI moves above the horizontal 30 reference level, it is viewed as a bullish indicator.
Conversely, an RSI that dips below the horizontal 70 reference level is viewed as a bearish indicator. Since some assets are more volatile and move quicker than others, the values of 80 and 20 are also frequently-used overbought and oversold levels.
Overbought Or Oversold? Using The RSI To Find Out
During uptrends, the RSI tends to remain more static than it does during downtrends. This makes sense because the RSI is measuring gains versus losses. In an uptrend, there will be more gains, keeping the RSI at higher levels. In a downtrend, the RSI will tend to stay at lower levels.
During an uptrend, the RSI tends to stay above 30 and should frequently hit 70. During a downtrend, it is rare to see the RSI exceed 70, and the indicator frequently hits 30 or under. These guidelines can help determine trend strength and spot potential reversals. For example, if the RSI isn't able to reach 70 on a number of consecutive price swings during an uptrend, but then drops below 30, the trend has weakened and could be reversing lower.
The reverse is true for a downtrend. If the downtrend is unable to reach 30 or below and then rallies above 70, that downtrend has weakened and could be reversing to the upside.
RSI Trendline Breaks
Momentum Indicators: RSI vs. MACD
Like RSI, moving average convergence divergence (MACD) is a trend-following momentum indicator that shows the relationship between two moving averages of a security’s price. The MACD is calculated by subtracting the 26-period exponential moving average (EMA) from the 12-period EMA. The result of that calculation is the MACD line.
A nine-day EMA of the MACD called the "signal line" is then plotted on top of the MACD line, which can function as a trigger for buy and sell signals. Traders may buy the security when the MACD crosses above its signal line and sell or short the security when the MACD crosses below the signal line.