RSI - The Overbought and Oversold Indicator
What is RSI
RSI stands for Relative Strength Index. It is a momentum oscillator developed by J. Welles Wilder in 1978 that measures the speed and magnitude of price changes to determine whether an asset is in an overbought or oversold state.
RSI is one of the most widely used indicators in technical analysis. It is applied across all markets including stocks, forex, futures, and cryptocurrencies, and is considered a fundamental reference tool for traders of all experience levels.
RSI tells you whether the price has risen or fallen too much, expressed as a number between 0 and 100.
Wilder also developed the ADX and Parabolic SAR. Understanding all three indicators together provides a solid foundation for technical analysis.
How RSI is Calculated
While you don't need to memorize the formula, understanding the calculation principle helps you better interpret RSI values.
Calculation Process
- Separate price changes over a period (default 14 days) into gains and losses.
- Calculate the average gain and average loss separately.
- Relative Strength (RS) = Average Gain / Average Loss
- RSI = 100 - (100 / (1 + RS))
The key concept is this: comparing the average size of up moves to the average size of down moves over a specific period.
- If the price rose every day for 14 days, losses would be zero, so RSI approaches 100.
- If the price fell every day for 14 days, gains would be zero, so RSI approaches 0.
- If gains and losses are similar, RSI hovers around 50.
Default Settings
| Setting | Default | Description |
|---|---|---|
| Period | 14 | Number of periods used in calculation |
| Overbought Level | 70 | Above this indicates overbought |
| Oversold Level | 30 | Below this indicates oversold |
Reducing the period (e.g., 7 days) makes RSI more sensitive and quicker to reach extreme values, but increases false signals. Increasing the period (e.g., 21 days) makes RSI more stable but signals arrive later.
Reading RSI: Overbought and Oversold
RSI ranges from 0 to 100 and is divided into three main zones.
| RSI Zone | Meaning | Interpretation |
|---|---|---|
| Above 70 | Overbought Zone | Price has risen significantly in the short term, correction possible |
| 30 to 70 | Neutral Zone | No extreme condition |
| Below 30 | Oversold Zone | Price has fallen significantly in the short term, bounce possible |
Overbought (RSI Above 70)
When RSI exceeds 70, it signals that recent price gains have been excessive, suggesting selling pressure may increase soon. However, be cautious: overbought doesn't mean the price will immediately drop. Interpreting RSI 70 as an automatic sell signal can lead to significant mistakes.
Oversold (RSI Below 30)
When RSI falls below 30, it signals that recent price declines have been excessive. This could present a buying opportunity, but again, there's no guarantee of an immediate rebound.
The Significance of the 50 Line
RSI 50 is the centerline where bullish and bearish momentum are balanced.
- If RSI stays above 50, bullish momentum dominates
- If RSI stays below 50, bearish momentum dominates
- RSI crossing above or below the 50 line can itself signal a trend change
RSI in Strong Trends: Watch for the Trap
One of the most common mistakes when using RSI is interpreting overbought/oversold signals as reversal signals during strong trends.
RSI During Uptrends
In a strong uptrend, RSI can remain at elevated levels even after reaching 70. RSI can climb to 80 or even 90 while prices continue rising. Selling based solely on overbought readings would mean missing most of the rally.
In strong uptrends, RSI tends to oscillate between 40 and 90. When RSI pulls back to the 40-50 zone, this often presents a buying opportunity.
RSI During Downtrends
The same applies to strong downtrends. After RSI falls below 30, it can remain at low levels or briefly rise before falling again.
In strong downtrends, RSI tends to oscillate between 10 and 60. When RSI rises to 50-60, this can signal another move lower.
Because of these characteristics, you should first determine whether the market is trending or ranging before using RSI. The ADX helps objectively assess trend strength.
RSI Divergence
One of the most powerful signals from RSI is divergence, which occurs when price movement and RSI movement go in opposite directions.
Bullish Divergence
This occurs when price makes a lower low, but RSI makes a higher low. While price continues falling, the momentum behind the decline is weakening. This suggests the downtrend may be ending and an upward reversal is possible.
Bearish Divergence
This occurs when price makes a higher high, but RSI makes a lower high. While price continues rising, the momentum behind the rally is weakening. This suggests the uptrend may be ending and a downward reversal is possible.
Divergence serves as an early warning of potential trend reversals, but it can take time for the actual reversal to occur. Rather than making trading decisions based on divergence alone, use it in conjunction with other evidence. For more on divergence types and applications, see the Divergence Guide.
Interpreting RSI in Cryptocurrency Markets
Cryptocurrency markets are significantly more volatile than traditional financial markets. This requires some adjustments when interpreting RSI.
Using 80/20 Thresholds
Some cryptocurrency traders use 80/20 thresholds instead of the traditional 70/30. Because of crypto's high volatility, RSI reaches 70 or 30 more frequently than in traditional markets. Using 80/20 can reduce false signals.
| Market | Overbought | Oversold | Notes |
|---|---|---|---|
| Traditional Stocks | 70 | 30 | Standard settings |
| Crypto (Conservative) | 80 | 20 | Reduces false signals |
| Crypto (Moderate) | 75 | 25 | Middle ground |
24/7 Market Characteristics
Unlike stocks, cryptocurrency markets operate 24 hours a day, 365 days a year. With no market close, there are fewer gaps, and RSI shows greater continuity. However, keep in mind that volatility can continue through weekends.
Timeframe Considerations
RSI can be used across various timeframes in cryptocurrency trading. However, shorter timeframes have more noise and generate more false signals.
- Weekly/Daily RSI: Useful for medium to long-term trend analysis. High reliability
- 4-Hour RSI: Suitable for swing trading. Moderate reliability
- 1-Hour or less RSI: For short-term trading. Many false signals, must be used with other indicators
Combining with Support and Resistance
Using RSI overbought/oversold signals together with support and resistance levels can improve trading accuracy.
Buy Scenario
- Price approaches a key support level.
- Simultaneously, RSI enters the oversold zone below 30.
- RSI begins rising back above 30.
- A bounce from support combined with oversold relief strengthens the buy case.
Sell Scenario
- Price approaches a key resistance level.
- Simultaneously, RSI enters the overbought zone above 70.
- RSI begins falling back below 70.
- Rejection at resistance combined with overbought relief strengthens the sell case.
RSI is most effective when used not in isolation, but in combination with price structure (support/resistance), trend indicators (MACD, moving averages), and volatility indicators (Bollinger Bands).
Key Takeaways for Using RSI
- Identify market conditions first: RSI overbought/oversold signals are more reliable in ranging markets than in trending markets.
- Overbought doesn't mean sell: In strong uptrends, RSI can remain overbought for extended periods.
- Watch for divergence: RSI divergence is one of the most powerful early warnings of trend reversals.
- Combine with other indicators: Don't make trading decisions based on RSI alone; always use it with other analysis tools.
- Adjust for the market: In cryptocurrency markets, consider adjusting overbought/oversold thresholds to 80/20.
Next article: Stochastic Oscillator - Measuring Price Position as a Percentage