This guide explains what the relative strength index (RSI) shows traders as a technical analysis indicator. We explore the various functions of an RSI and what kind of insight traders can generate by using it on a chart.
Contents
Read on to learn about how to spot potential buy, sell, and exit signals by using the RSI. More, you can learn about RSI divergences and how these can confirm desirable trading positions.
What Is Relative Strength Index?
The Relative Strength Index (RSI) is one of the more popular technical analysis tools.
It is an oscillator that measures current price strength in relation to previous prices.
The RSI can be a versatile tool, it might be used to:
- Generate potential buy and sell signals
- Show overbought and oversold conditions
- Confirm price movement
- Warn of potential price reversals through divergences
How To Spot Buy And Sell Signals With RSI
The relative strength index can be used to amplify trading strategies by making more informed decisions on market entry and exit points.
Traders call these buy and sell signals.
How To Read Potential Buy Signals With RSI
A trader might buy when the RSI crosses above the oversold line (30).
You can see 6 different points on the example chart below, where the oversold line was crossed for Gold. In this instance, a trader might find it profitable to enter the trade.
Please note, this is an example – not a recommendation.
How To Read Potential Sell Signals With RSI
A trader might sell when the RSI crosses below the overbought line (70). Varying the time period of the Relative Strength Index might increase or decrease the number of buy and sell signals.
In the chart below of Gold, two RSI time periods are shown, 14-day (default) and 5-day.
Notice how in this example, decreasing the time period made the RSI more volatile, increasing the number of buy and sell signals substantially.
There is another way a trader might interpret Relative Strength Index buy and sell signals. This, and how to interpret RSI divergences, is all contained on the next page.
Reading Buy & Sell Signals Via Divergence
An alternative way that the Relative Strength Index (RSI) may give buy and sell signals is given below:
- A trader might buy when price and the Relative Strength Index are both rising and the RSI crosses above the 50 Line.
- Similarly, a trader might sell when the price and the RSI are both falling and the RSI crosses below the 50 Line.
An example of this potential methodology for buying and selling based on 50 Line crosses is given below in the chart of Wal-Mart (WMT):
For another method for using the RSI indicator for potential buy and sell signals, see our guide on the Stochastic RSI. This technique combines both the popular Stochastics indicator and the Relative Strength Index.
RSI Confirmations & Divergences
Another usage for the Relative Strength Index is to attempt to confirm price moves and attempt to forewarn of potential price reversals through RSI Divergences.
The E-mini Nasdaq 100 Futures contract chart above shows the RSI confirming price action, along with a warning of future price reversals.
What Does Low #1 to Low #2 Show?
The E-mini Nasdaq 100 Futures contract’s price made a substantial move from Low #1 to Low #2.
The RSI confirmed this move, which may have helped a trader have confidence in jumping on board the price move higher.
The break of trendline of the e-mini future was also confirmed by the trendline break of the Relative Strength Index, suggesting that the price move may likely be over.
What Does Low #3 to Low #4 Show?
A bullish divergence was registered between Low #3 and Low #4. The e-mini Nasdaq 100 future made lower lows, but the RSI failed to confirm this price move, only making equal lows.
A trader might see this RSI divergence and begin taking profits from their short sells.
What Does High #1 to High #2 Show?
A bearish divergence occurred when the e-mini futures contract made a higher high and the RSI made a lower high.
This bearish divergence suggested that prices could shortly be reversing the trend.
A trader might consider reducing their long position, or even completely selling out of their long position.
Where To Start Trading With RSI?
If you are interested in trading using technical analysis, have a look at our reviews of these regulated brokers available in to learn which tools they offer:
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. Between 74%-89% of retail investor accounts lose money when trading CFDs. You should consider whether you can afford to take the high risk of losing your money.
FAQs
What does relative strength index mean?
The relative strength index (RSI) is an oscillator — reading the RSI of a chart allows you to measure the strength and prominence of existing price trends in comparison to previous price trends. The RSI is also used to spot buy and sell signals, divergences, and to determine whether an asset is overbought or oversold.
Who invented the RSI?
The relative strength index was created by J. Welles Wilder, first published as a technical analysis as part of his book New Concepts in Technical Trading Systems. Wilder’s book was published in 1978 in magazines like the Commodities Magazine and the Futures Magazine before becoming one of the most used technical indicators in trading.
How do I calculate the relative strength index in excel?
To calculate the RSI in excel, you need a list of gains and losses from the past time frame you’re calculating the RSI in relation to. Create 2 excel columns, list the gains in, while the losses in the other. Calculate the average gains and losses for each time point by using this formula: (Current Value + (Previous Average * (Number of Periods – 1)) / Number of Periods. To get the relative strength value, divide the average gains by the average losses for each time point.
What is the relative strength of a stock?
The relative strength index of a stock measures the strength of the stock’s trend in the particular direction it’s going. Since the RSI is calculated by dividing the average gains by the average losses of a stock over a given time period, you can gain insight into the current directional strength of the stock, as well as the likelihood of divergence.
Further Reading
You can explore more technical analysis tools and guides written by our experts:
- Simple Moving Average
- Stochastic RSI
- Swing Index
- Triangular Moving Average
- Triple Exponential Avg
- Typical Price Moving Avg
- Ulcer Index
Traders looking for guidance on the type of instrument to enter a market with can look at our trading guides on CFDs, options, cryptocurrencies, stocks, forex, and bullion.
Familiar with instruments, but don’t know what to trade? Check out some of our commodity guides on precious metals, energy commodities, and agricultural commodities.
