The Relative Strength Index (RSI) is a widely used momentum oscillator that helps assess the strength and potential reversals of a price trend by calculating and comparing the magnitude of recent price gains to recent price losses over a specified period.
RSI Calculation
Calculate the price change (gain or loss) for each period
Calculate the average gain and average loss over the specified period.
Calculate the relative strength (RS) by dividing the average gain by the average loss.
Calculate the RSI using the formula: RSI = 100 - (100 / (1 + RS))
Interpretation
The RSI provides insights into the prevailing trend of the asset.
RSI reading above 50 indicates that the bullish tendency is stronger than the bearish tendency, and a reading below 50 indicates that the bearish tendency is stronger than the bullish tendency.
Specifically, reading above 70 suggests that the asset is overbought, indicating a potential price reversal or correction. Conversely, a reading below 30 suggests that the asset is oversold, indicating a potential price bounce or recovery.
However, as mentioned in the previous "Stochastic Oscillator" post, the extreme zone does not mean a trading signal. Instead, one should wait for confirmation such as breaking above/below the oversold/overbought region.
Furthermore, similar to other indicators, a signal line (moving average) can be added to provide insight. When the RSI crosses above the signal line (Golden cross), it generates a bullish signal, suggesting that the asset may experience upward price movement. Conversely, when the RSI crosses below the signal lineĀ (Death cross), it generates a bearish signal, indicating a potential downward price movement.
Divergence
Indicators may move in a reverse direction of the price trend: "Divergence." The divergence of oscillators suggests that the trend may reverse soon. However, as always, confirmation is crucial; you cannot solely enter the trade depending on divergence but should confirm with price action and other indicators.
Real Chart
