Relative Strength Indicator

What is a Relative Strength Indicator?

The Relative Strength Indicator (RSI) is a mean reversion indicator used in technical analysis.

RSI looks at the average gains and losses in an asset’s price over a set period (usually 14 days) to determine the extent to which the price of the asset is trending upwards or downwards.

The ratio of these recent gains and losses are normalised to produce a number that can oscillate between 0 and 100. The indicator was originally developed by J. Welles Wilder Jr. and introduced in his seminal 1978 book, “New Concepts in Technical Trading Systems.”

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What you need to know:

  • RSI looks at the average gains and losses in an asset’s price over a set period (usually 14 days) to determine the extent to which the price of the asset is trending upwards or downwards.
  • Traditionally, an RSI of 70 and above indicates that the asset may be overbought and is due for a corrective downturn - a signal to buy.
  • An RSI of 30 or below indicates that the asset may be oversold, and due for a corrective upturn - a signal to sell.

How is RSI calculated?

RSI is calculated in two steps.

What does it mean?

Traditionally, an RSI of 70 and above indicates that the asset may be overbought and is due for a corrective downturn, while an RSI of 30 or below indicates that the asset may be oversold, and due for a corrective upturn. As such, traders who use RSI may see an RSI of 70 or above as a signal to buy, and an RSI of 30 or below, as a signal to sell.

Example

The below charts for Visa Inc. illustrate some RSI overbought and oversold events.

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There are three occurrences where the RSI crosses the overbought (70) or oversold (30) thresholds, and each one is followed by a large price change:

  1. 28th August 2020 - RSI goes above 70 and is followed by a price drop of 7% over the next month.
  2. 28th October 2020 - RSI goes below 30 and is followed by a price rise of 17% over the next two weeks.
  3. 28th April 2021 - RSI goes above 70 and is followed by a price drop of 5% over the next two weeks.

There are also two other occasions (January 2021 and March 2021) where the RSI reaches close to 70 and is then followed by a steep price drop.

Limitations

However, obviously, not all assets are the same, and if an asset has an RSI consistently above 70 or below 30, the overbought and oversold thresholds may need to be changed, for example to 80 and 20 respectively. It can also be true, during bull or bear markets, for an asset to remain consistently overbought or oversold for some days before correcting.

As with all pieces of financial or price data, RSI is risky to use as a standalone signal. It’s wiser to analyse a number of different indicators and use their combination to decide if an asset price will continue to move in its current direction, or if it is likely to reverse.