What is RSI?
💡 Definition
The Relative Strength Index (RSI) is a momentum oscillator that measures the speed and magnitude of recent price changes to evaluate overbought or oversold conditions. Developed by J. Welles Wilder Jr. in 1978, RSI oscillates between 0 and 100, with readings above 70 typically indicating overbought conditions and readings below 30 indicating oversold conditions.
RSI is one of the most popular technical indicators used by traders worldwide. It helps identify potential reversal points, confirm trend strength, and spot divergences that may signal trend changes. While powerful, RSI works best when combined with other analysis techniques like price action and market structure.
Visual Representation
RSI Indicator Display
RSI oscillates between 0-100, with 70+ indicating overbought and 30- indicating oversold conditions
The Three RSI Zones
Overbought (70-100)
Meaning: Price has risen rapidly and may be due for a pullback or reversal
Signal: Potential selling opportunity, especially if divergence forms
Caution: Strong trends can remain overbought for extended periods
Neutral (30-70)
Meaning: Price momentum is balanced, neither extreme
Signal: No clear overbought/oversold signal, trend continuation likely
Usage: Look for crossovers of the 50 level for directional bias
Oversold (0-30)
Meaning: Price has fallen rapidly and may be due for a bounce or reversal
Signal: Potential buying opportunity, especially if divergence forms
Caution: Strong downtrends can remain oversold for extended periods
RSI Calculation
How RSI is Calculated
Standard Period: 14 periods (days, hours, minutes depending on timeframe)
Step 1: Calculate average gains and losses over 14 periods
Step 2: Divide average gain by average loss to get RS (Relative Strength)
Step 3: Apply the RSI formula to normalize the value between 0 and 100
Note: Most trading platforms calculate this automatically. Understanding the formula helps you interpret the indicator better.
RSI Trading Strategies
Popular RSI Trading Methods
1. Overbought/Oversold Trading
The most basic strategy: sell when RSI crosses above 70 (overbought), buy when RSI crosses below 30 (oversold). Best used in ranging markets. Wait for price confirmation before entering.
2. RSI Divergence Trading
Look for divergences between price and RSI. When price makes new highs but RSI doesn't (bearish divergence), or price makes new lows but RSI doesn't (bullish divergence), a reversal may be imminent.
3. RSI Trendline Breaks
Draw trendlines on the RSI itself. When RSI breaks its trendline, it often signals a trend change before price does. This provides early warning signals.
4. RSI 50 Line Crossover
The 50 level acts as a momentum gauge. RSI above 50 suggests bullish momentum, below 50 suggests bearish momentum. Crossovers can signal trend changes.
5. RSI Hidden Divergence
In strong trends, look for hidden divergence. Price makes higher low but RSI makes lower low (bullish continuation), or price makes lower high but RSI makes higher high (bearish continuation).
6. Multiple Timeframe RSI
Check RSI on multiple timeframes. For example, if daily RSI is oversold and 4H RSI crosses above 30, it can provide high-probability buy setups aligned with larger trends.
RSI Divergence Types
Understanding RSI Divergences
Divergences are among the most powerful signals RSI provides, often predicting trend reversals before they occur.
🔴 Regular Bearish Divergence
Price: Makes higher high
RSI: Makes lower high
Signal: Uptrend losing momentum, potential reversal down
Action: Consider taking profits or shorts
🟢 Regular Bullish Divergence
Price: Makes lower low
RSI: Makes higher low
Signal: Downtrend losing momentum, potential reversal up
Action: Consider taking profits or longs
🟢 Hidden Bullish Divergence
Price: Makes higher low
RSI: Makes lower low
Signal: Uptrend continuation, pullback ending
Action: Look for long entries
🔴 Hidden Bearish Divergence
Price: Makes lower high
RSI: Makes higher high
Signal: Downtrend continuation, bounce ending
Action: Look for short entries
Using RSI Effectively
- Confirm with Price Action: Never trade RSI signals alone - always wait for price confirmation (candlestick patterns, support/resistance)
- Consider Market Context: In strong trends, RSI can remain overbought/oversold for long periods - respect the trend
- Adjust for Volatility: In highly volatile markets, consider using 80/20 levels instead of 70/30
- Multiple Timeframes: Check RSI on higher timeframes for context before trading lower timeframe signals
- Combine with Support/Resistance: RSI signals are more reliable when they occur at key price levels
- Watch for Divergences: Regular divergences often provide the strongest reversal signals
- Use Appropriate Settings: While 14 is standard, shorter periods (7-9) are more sensitive, longer periods (21-25) are smoother
- Don't Counter-Trend Trade: In strong trends, don't short just because RSI is overbought or buy just because it's oversold
RSI in Smart Money Concepts
While RSI is a traditional indicator, it can complement SMC trading when used correctly:
✦ Confirm Order Block Entries: RSI oversold in discount zone or overbought in premium zone adds confluence
✦ Divergence at Structure: RSI divergence at CHoCH or BOS levels provides early reversal warnings
✦ Momentum Confirmation: Strong RSI readings confirm strong impulsive moves by Smart Money
✦ Filter False Signals: Weak RSI momentum during inducement can help identify fake breakouts
✦ Trend Strength: RSI staying above/below 50 confirms continuation of market structure
Remember: RSI is a tool to support your SMC analysis, not replace it. Price action and market structure should always be your primary focus.
Common RSI Mistakes
⚠️ Avoid These RSI Pitfalls
RSI is powerful but often misused. Here are the most common mistakes traders make:
- Trading overbought/oversold signals blindly without considering trend direction
- Expecting immediate reversals when RSI hits 70 or 30 - price can stay extreme for long periods
- Ignoring price action and market structure - RSI is a supplementary tool, not a standalone system
- Using the same RSI settings for all market conditions and timeframes
- Missing divergences because you're only watching the overbought/oversold levels
- Counter-trend trading in strong trending markets just because RSI shows extreme readings
- Not waiting for price confirmation before entering trades based on RSI signals
- Overcomplicating analysis by adding too many indicators alongside RSI
RSI Settings and Customization
- Standard Setting (14): Most common, balanced between sensitivity and reliability
- Fast RSI (7-9): More sensitive, gives earlier signals but more false positives, good for scalping
- Slow RSI (21-25): Less sensitive, smoother line, fewer false signals, good for swing trading
- Overbought/Oversold Levels: Standard 70/30, but can use 80/20 for less frequent signals or 60/40 for ranging markets
- Color Coding: Many traders color RSI differently above/below 50 for easier visual trend identification
- Multiple RSI Strategy: Some traders use multiple RSI periods simultaneously (like 7 and 21) for confluence