What is the RSI indicator?

What the RSI is

The RSI, or Relative Strength Index, is a momentum indicator that measures the speed and size of recent price moves on a scale from 0 to 100. Developed by J. Welles Wilder in 1978, it compares the average size of recent gains to recent losses to gauge how strong and how stretched a move is. It appears as a line in a separate panel below the price chart, swinging between 0 and 100.

The idea is simple: when buying has dominated and pushed RSI high, the move may be getting overextended; when selling has dominated and pushed it low, the fall may be overdone. RSI does not tell you direction on its own, it tells you about momentum, which is why it pairs naturally with support and resistance and candlestick patterns.

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How RSI is calculated

Your platform does the maths, so you never need to work RSI out by hand. Knowing what goes into the number still pays off, because it explains most of RSI's behaviour, including why it can sit near 70 for weeks.

Take the last 14 candles and treat each close-to-close change as either a gain or a loss. Add up the gains, add up the losses, and divide each total by 14 (all 14 periods, not just the number of up or down candles). That gives the average gain and the average loss. Divide one by the other and you have RS, the relative strength. The final step squeezes RS onto the 0 to 100 scale.

After that first reading, Wilder smoothed the averages instead of starting fresh each candle: the new average gain is the previous average gain times 13, plus the latest gain, divided by 14 (the same for losses). That smoothing is why RSI moves steadily and one big candle does not reset it. A few charting packages use a simple average instead, which is why two platforms can show slightly different RSI values on the same chart.

One number worth remembering: RSI only reaches 70 when average gains are more than 2.33 times average losses, and only drops to 30 when losses are more than 2.33 times gains. Those are genuinely lopsided stretches of trading, which is why the levels mean something.

Overbought and oversold

The two levels that matter most are 70 and 30, Wilder's original thresholds. Above 70, RSI is in overbought territory: momentum is strong and the move may be due a pause. Below 30, it is oversold: the decline may be overdone. The 50 midline separates bullish momentum (above) from bearish (below).

This is how I read the levels. RSI crossing above 70 tells you buyers are strong, which on its own is not a reason to sell. RSI turning back down through 70 tells you that strength is fading, which is the start of a case. Even then I want price to agree, with a bearish candle at resistance or a break of the last swing low, before I act. The same logic runs in reverse at 30.

The trend trap: overbought can stay overbought

The most expensive RSI habit I see is shorting every reading above 70. In a strong trend, RSI can tag 70 again and again while price keeps grinding higher.

Two things to take from this. First, the 50 line works as a trend filter: while pullbacks keep holding in the 40 to 50 area, the uptrend is intact, and buying those dips makes more sense than selling the highs. Second, in trends like this some traders move the thresholds out to 80 and 20 so that only real extremes register. In a downtrend, flip it: RSI tends to live between 20 and 60, and rallies that stall around 50 to 60 are where sellers step back in.

How traders use it

RSI is most valuable as a confirmation tool rather than a standalone signal. A few common, sensible uses:

• Confirming a reversal at a level. When price reaches support or resistance and RSI is also oversold or overbought, the two together are stronger than either alone.
• Reading the 50 midline for trend. RSI holding above 50 supports a bullish bias; below 50 supports a bearish one. Some trend traders use the midline rather than the 70/30 extremes.
• Filtering with the trend. In an uptrend, oversold RSI pullbacks can mark buying opportunities in the direction of the trend, which is safer than shorting overbought readings against it.

The thread through all of these is that RSI confirms an idea you already have from price; it rarely pays to trade on RSI alone.

Divergence: the higher-quality signal

The signal experienced traders value most from RSI is divergence, where price and RSI disagree.

• Bullish divergence: price makes a lower low, but RSI makes a higher low. The new low came on less selling force, hinting the downtrend is fading.
• Bearish divergence: price makes a higher high, but RSI makes a lower high. The new price high came on weaker momentum, hinting the uptrend is tiring.

Divergence is generally more reliable than the raw 70/30 levels because it speaks to the momentum behind a move rather than just its extremity. It still needs confirmation, a candlestick reversal or a level break, before acting. A warning from experience: divergence can repeat. In a strong trend you can see two or three bearish divergences in a row before the top actually arrives, which is why the trigger has to come from price, not from RSI.

Free RSI cheat sheet (PDF)

I put the working parts of this guide onto one A4 page: the formula and default settings, the four signals drawn on a chart, a table of what each signal means and how to act on it, five rules of thumb, and the three mistakes I see most often. Print it, or keep it open next to your charts.

Common mistakes

Most RSI failures come from a handful of repeated errors:

• Selling every time RSI hits 70. In a strong trend this fights the move and bleeds the account. Overbought is a caution, not a sell button.
• Acting on divergence too early. Divergence can repeat before a turn. Wait for price to confirm it.
• Using RSI alone. No single indicator is enough. RSI needs the context of trend, structure and confirmation.
• Over-optimising the settings. Endlessly tweaking the period chases noise. The default 14 is fine for almost everyone.
• Ignoring risk management. The indicator does not protect the account; a stop loss and proper position size do.

Used as one input among several, with the trend and a defined risk, RSI earns its place. Build the rest of the foundation with candlestick patterns, support and resistance and forex trading strategies, and choose a broker with strong charting from the best forex brokers in Australia ranking.

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