What is RSI, how to calculate it, and techniques for using it

RSI (Relative Strength Index) is a famous technical analysis tool that most traders are familiar with. However, misconceptions about how to use it have led to many losing money. The main reason is that experts do not use RSI to predict trend reversals but rather to read the strength of market momentum instead.

Understanding the True Nature of RSI

RSI (Relative Strength Index) was developed by J. Welles Wilder Jr. and released in 1978. It is one of the most popular technical analysis tools in the trading world.

The most common mistake is applying RSI straightforwardly with incorrect understanding in two main points:

RSI is a Momentum Oscillator, not a predictor of trend reversals.

Its primary function is to measure the (Momentum) of the market. It is designed to assess the speed (Velocity) and magnitude (Magnitude) of price changes to evaluate whether buying or selling pressure is dominant.

This indicator produces a line graph that moves within the range of 0 to 100.

The Correct Meaning of “Relative Strength”

The term “Relative Strength” in the RSI name does not refer to comparing the strength between two different assets. Instead, it compares the buying versus selling pressure within the same asset.

In other words, RSI measures the average buying power relative to the average selling power of an asset over a specified period to determine who is controlling the market.

Therefore, RSI is a “momentum gauge,” not a “reversal indicator.” When RSI rises high, it does not necessarily mean the price must fall; rather, it signals that the buying momentum is currently strong.

How to Calculate RSI

For most traders, calculating RSI manually is unnecessary because most trading platforms do it automatically. However, understanding the underlying concept of the formula will help you use it more effectively.

The core of RSI calculation lies in the variable RS (Relative Strength):

RS = Average Gain / Average Loss

where:

• Average Gain (AvgU): the mean of upward price movements over the period (Standard 14 candles)
• Average Loss (AvgD): the mean of downward price movements over the same period (taken as positive values)

Important points to understand

• When Average Gain > Average Loss (buying pressure exceeds selling pressure), RS > 1, and RSI moves above 50.
• When Average Gain < Average Loss (selling pressure exceeds buying pressure), RS < 1, and RSI drops below 50.
• When Average Gain = Average Loss (balanced), RS = 1, and RSI equals 50.

The 50 line is the true dividing line, not the 70 or 30 lines that many consider as critical points.

Basic Use of RSI

When you first open an RSI chart, you will see the 70 and 30 lines as standard thresholds. Traditional teachings say:

Overbought (Too much buying): When RSI is above 70, it indicates the price is overextended, buying pressure is high, and it’s time to look for sell signals.

Oversold (Too much selling): When RSI is below 30, it indicates the price is undervalued, selling pressure is high, and it’s time to look for buy signals.

This sounds simple, but it can be a dangerous trap.

Why the 70/30 Overbought/Oversold Strategy Fails

The main problem is “trends” (Trends). In strong trending markets, whether up or down, RSI can stay in the Overbought (>70) or Oversold (<30) zones for a very long time.

For example, in a strong uptrend, RSI may remain above 70 for weeks because it reflects persistent buying momentum. If traders sell every time RSI hits 70, thinking it’s overbought, their portfolios may blow up before the price actually drops. This is a dangerous trend-following mistake.

Similarly, in a strong downtrend, RSI can stay below 30 for extended periods. Buying just because it’s oversold is like “catching a falling knife.”

When does the 70/30 Strategy Work?

This approach works well in sideways markets or trading ranges (Trading Ranges). In such cases, buying near 30 (close to support) and selling near 70 (close to resistance) can be effective.

Professional Techniques for Using RSI

These techniques distinguish successful traders from amateurs.

1. Divergence - A Powerful Warning Signal

Divergence occurs when the price and indicator move in opposite directions. It signals that the current trend may be losing strength.

Bullish Divergence (Bullish Signal)

• Occurs in a downtrend
• Price makes new lows, but RSI does not follow, forming higher lows
• Indicates weakening selling pressure; market may reverse upward
• Most reliable when occurring in Oversold territory (<30)

Bearish Divergence (Bearish Signal)

• Occurs in an uptrend
• Price makes new highs, but RSI does not follow, forming lower highs
• Indicates weakening buying pressure; market may reverse downward
• Most reliable when occurring in Overbought territory (>70)

2. Failure Swings - Strong Confirmation Signals

Wilder identified Failure Swings as the most powerful confirmation of trend reversal.

Failure Swing Top (Bearish Confirmation)

• RSI rises above 70 (forming a high)
• Price makes a new high, but RSI fails to reach 70
• Key point: RSI breaks below its previous low (Fail Point)
• This confirms momentum has shifted to bearish, signaling a sell

Failure Swing Bottom (Bullish Confirmation)

• RSI drops below 30 (forming a low)
• Price makes a new low, but RSI does not go below 30
• Key point: RSI breaks above its previous high
• This confirms momentum has shifted to bullish, signaling a buy

3. Centerline Crossover - Using the 50 Line as a Compass

For trend followers, the 50 line can be more important than 70/30.

• RSI > 50: Bullish market, buying pressure dominates; look for buy or hold long
• RSI < 50: Bearish market, selling pressure dominates; look for sell or hold short

4. Adjust RSI Zones According to Trend

This is an advanced technique to refine your RSI usage.

In a strong uptrend

• RSI rarely drops to 30
• It moves within roughly 40-90
• The 40-50 zone acts as a new support
• Professionals wait to buy when RSI pulls back to 40-50 and bounces, not at 30

In a strong downtrend

• RSI rarely rises to 70
• It moves within roughly 10-60
• The 50-60 zone acts as a new resistance
• Professionals wait to sell when RSI rises to 50-60 and then turns down, not at 70

RSI Weaknesses and How to Address Them

No indicator is perfect 100%. RSI has its limitations.

False signals: RSI can give false signals, especially in volatile markets.

Trend failure: The biggest weakness. RSI can stay in overbought ###>70( or oversold )<30 zones for a long time, causing traders to chase the trend and suffer heavy losses.

Lagging indicator: RSI is based on past 14 candles, so it always lags behind price.

Divergence does not mean immediate reversal: Divergence can warn well in advance; the price may continue in the same trend for a long time before reversing.

How to Improve RSI Effectiveness

Never rely on RSI alone. Use the “Confluence” technique—look for confirmation signals from 2-3 other tools pointing in the same direction.

Combine RSI + Price Action

• Don’t buy just because RSI hits 30
• Buy when RSI hits 30 and price reaches a key support level
• Sell when Bearish Divergence appears and price hits a key resistance

Combine RSI + MACD

• MACD confirms trend direction
• RSI helps pinpoint entry timing
• Wait for confluence: RSI shows Bullish Divergence and MACD crosses up

Practical Example of RSI Trading

Suppose you are trading Commodity on a 4-hour timeframe.

Step 1: Analyze the bigger picture Open daily charts and observe continuous upward movement approaching a key psychological resistance.

Step 2: Look for warning signals Price makes a new high, but RSI does not follow—Bearish Divergence.

Step 3: Wait for confirmation signals

• Failure Swing: RSI breaks below previous low
• Centerline: RSI crosses below 50
• Price Action: Candlestick reversal pattern

Step 4: Enter the trade When all three signals align, open a sell order.

Step 5: Manage risk Place Stop Loss above the latest high, and set Take Profit at the next support level.

Summary

RSI is an excellent momentum indicator but not a 100% accurate predictor of reversals.

Understanding its features and limitations, combined with integrating RSI with other analysis tools, separates professional traders from amateurs.

Continuous practice and real trading experience will help you master RSI and other analysis tools to improve your trading performance, whether trading Forex, gold, oil, indices, or other assets.