RSI

What the RSI is

The relative strength index is a straightforward indicator for telling when a pair has been overbought or oversold by its recent price action. Traders use it widely because it is easy to read: it says whether a pair is overpriced or underpriced given its recent trading history.

How it reads

The RSI is an oscillating momentum indicator that moves between 0 and 100. A reading of 30 or below is taken as oversold, the pair below its worth on recent price action; a reading of 70 or above is taken as overbought, the pair priced too high relative to recent price action. Some traders tighten those lines to 20 and 80 to be more confident about the move.

The calculation

RSI = 100 - 100 / (1 + RS), where RS is the average gain over the periods that gained divided by the average loss over the periods that lost, across a chosen window. It pits a pair's upward momentum against its downward momentum to show whether the current momentum is out of character with its recent moves. The usual window is 14 periods. It can be shortened or lengthened; a shorter setting such as 5 reacts faster and suits more volatile, higher-risk moves.

Trading with it

If the RSI goes above 70, the pair is usually too expensive and its price may come down soon; below 30, it may be too cheap and the momentum could shift. It is not perfect. Sudden large moves can distort it, so use it together with other tools, and remember it is most helpful when prices are stable. That is also why some traders prefer 80 and 20 to 70 and 30.

Divergence

When price is falling and setting lower lows while the RSI climbs and sets higher lows, that is a bullish divergence: the downward momentum may be weakening. The reverse, price setting higher highs while the RSI falls, is a bearish divergence. Divergences can be misleading inside a strong trend, so read them together with other momentum tools.

Failure swings

A failure swing is a pattern in the RSI itself, independent of price, that points to a likely reversal. A bullish failure swing: the RSI drops briefly below 30 and bounces, falls back to hold just above 30, then bounces again and breaks its prior high. A bearish failure swing is the opposite around 70: the RSI breaks below its previous low after failing at the top.

Did it help

Note the RSI reading and any divergence in the journal entry for each trade. Over a few dozen trades the journal tells you whether the indicator added anything, or only agreed with what you already wanted to do.