RSI

Relative Strength Index; momentum oscillator measuring overbought/oversold conditions.

The Relative Strength Index (RSI) is a popular momentum oscillator used in technical analysis to measure the speed and magnitude of recent price changes. Developed by J. Welles Wilder Jr., it evaluates whether an asset is overvalued (overbought) or undervalued (oversold) by comparing the strength of its advancing days to its declining days over a set period, typically 14 days. The RSI is plotted on a scale from 0 to 100. Traditionally, an RSI reading above 70 indicates that an asset is becoming overbought or overvalued, suggesting it may be primed for a trend reversal or a corrective price pullback. Conversely, an RSI reading below 30 indicates an oversold or undervalued condition, which may signal an upcoming trend reversal or price bounce. While RSI is a valuable tool for identifying potential entry and exit points, retail investors should use it with caution. In strong, sustained trends, an asset can remain in overbought or oversold territory for a long time without a reversal. Therefore, many traders look for additional signals, such as "divergence"—where the asset price makes a new high or low but the RSI does not—or combine RSI with other technical indicators to confirm trends before making a trade.

Suppose Stock XYZ has been trading for 14 days. Over this period, the average gain on days when the price went up is $1.50, and the average loss on days when the price went down is $0.50. First, calculate the Relative Strength (RS) as 1.50 / 0.50 = 3. Next, apply the RSI formula: RSI = 100 - (100 / (1 + 3)) = 100 - (100 / 4) = 100 - 25 = 75. Since 75 is above 70, the stock is considered overbought.