Definition
The Relative Strength Index (RSI) is a momentum oscillator that measures the speed and magnitude of directional price movements. Developed by J. Welles Wilder Jr., RSI provides a visual representation of a market's current and historical strength or weakness based on closing prices over a specified period. It’s widely used for analyzing cash-settled instruments (like stock indexes) and leveraged derivatives, offering reliable insights into price and momentum shifts.
History
J. Welles Wilder Jr., a mechanical engineer and commodity trader, introduced RSI in his 1978 book, New Concepts in Technical Trading Systems. Originally designed for commodity markets, RSI gained global popularity and is now a cornerstone of technical analysis. Andrew Cardwell later expanded Wilder’s work, using RSI for trend confirmation and refining its interpretations.
Calculation
RSI is calculated as:
RSI = 100 – 100 / (1 + RS)
RS = Average Gain of *n* days UP / Average Loss of *n* days DOWN Practical Example (Pine Script):
change = change(close)
gain = change >= 0 ? change : 0.0
loss = change < 0 ? (-1) * change : 0.0
avgGain = rma(gain, 14)
avgLoss = rma(loss, 14)
rs = avgGain / avgLoss
rsi = 100 - (100 / (1 + rs)) 👉 Learn more about RSI calculations
Key Concepts
1. Overbought/Oversold Levels
- Overbought: RSI > 70 suggests potential selling opportunities.
- Oversold: RSI < 30 indicates potential buying opportunities.
- Traders may adjust thresholds (e.g., 80/20) for tighter signals.
2. Divergence
- Bullish Divergence: Price makes a lower low, but RSI forms a higher low → Potential upward reversal.
- Bearish Divergence: Price makes a higher high, but RSI forms a lower high → Potential downward reversal.
3. Failure Swings
Bullish Failure Swing:
- RSI drops below 30 (oversold).
- Bounces above 30.
- Pulls back but stays above 30.
- Breaks prior high.
Bearish Failure Swing:
- RSI rises above 70 (overbought).
- Drops below 70.
- Rebounds but stays below 70.
- Falls below prior low.
4. Trend Confirmation (Cardwell’s Insights)
Divergence often signals trend continuation, not reversal.
- Bullish divergence in downtrends = temporary correction.
- Bearish divergence in uptrends = minor pullback.
Positive/Negative Reversals:
- Positive: Price higher low + RSI lower low → Confirms bullish trend.
- Negative: Price lower high + RSI higher high → Confirms bearish trend.
👉 Master trend analysis with RSI
Practical Applications
Inputs & Customization
- RSI Length: Default 14 periods (adjustable).
- Source: Typically closing prices.
- Divergence Calculation: Highlights bullish/bearish flags.
- Smoothing: Reduces noise for clearer signals.
FAQs
Q1: What’s the ideal RSI period for day trading?
A: While 14 is standard, shorter periods (e.g., 9) suit volatile markets, while longer periods (e.g., 25) filter noise for swing trading.
Q2: Can RSI be used alone?
A: No. Combine with volume analysis, moving averages, or support/resistance levels for higher accuracy.
Q3: Why does RSI divergence sometimes fail?
A: Divergence signals potential reversals but requires confirmation (e.g., candlestick patterns or breakouts).
Q4: How does RSI differ from MACD?
A: RSI measures momentum magnitude (0–100 scale), while MACD tracks trend direction via moving averages.
Q5: Is RSI effective in ranging vs. trending markets?
A: Best in ranging markets (overbought/oversold signals). In trends, use Cardwell’s methods for confirmation.
Q6: What’s a common RSI pitfall?
A: Overreliance on default 70/30 levels without context. Always assess market structure first.
Summary
RSI remains a vital tool for traders, blending Wilder’s momentum principles with Cardwell’s trend-confirmation techniques. Whether identifying overbought conditions or spotting divergences, RSI’s versatility makes it indispensable.
👉 Explore advanced RSI strategies
Pro Tip: Backtest RSI settings on historical data to refine your strategy before live trading.