Relative Strength Index (RSI)

The Relative Strength Index (RSI) is a momentum indicator calculated using a specific formula. It was developed by J. Welles Wilder Jr., who introduced it in 1978. His aim was to express price momentum on a uniform scale so that the values of different shares – and other instruments – could be compared with each other. This is why the RSI always moves within a range of 0 to 100.

How the RSI is calculated

The calculation is usually based on 14 periods – on a daily chart, that means 14 trading days. First, the average gain on up days and the average loss on down days within this period are determined. The ratio of the two is called the relative strength (RS):

RSI = 100 − 100 / (1 + RS)

Here, RS is the average gain divided by the average loss.

Example: if a share has gained an average of $1.50 on its up days and lost an average of $0.75 on its down days, RS is 2. The RSI is then 100 minus 100 divided by 3, or about 66.7: buyers have clearly been in control, but the value is still below the overbought threshold.

How traders interpret the RSI

The levels 30 and 70 have a special meaning:

• RSI below 30: the market is considered oversold. Sellers have dominated, and a recovery in the price may follow soon.
• RSI above 70: the market is considered overbought. Buyers have dominated, and many traders see this as a warning that prices may fall back.

These levels are not automatic trading signals, however. In strong trends, the RSI can remain in overbought or oversold territory for a long time. Many traders therefore also watch for divergences between the price and the RSI and combine the indicator with other tools such as the MACD or Bollinger Bands. The RSI is one of the standard indicators of technical analysis and is available on virtually every trading platform.