What is the relative strength index (RSI)?

Concept of Relative Strength Index RSI

Relative Strength Index (RSI) - is one of the most popular technical indicators in the world of trading. It was developed in 1978 by technical analyst J. Welles Wilder. RSI measures the speed of price changes of a financial asset, providing insight into the strength of the current trend and potential reversal points.

The RSI formula calculates the ratio of gains to losses over a specific period, usually 14 days, and is evaluated on a scale from 0 to 100. The main principle of using RSI is that prices move in cycles. Understanding when the market price has excessively risen or fallen helps identify potential reversal levels and use trading opportunities.

How to Read RSI Signals

RSI gives four main signals. First of all, it indicates overbought and oversold conditions — the primary RSI signal, where a level above 70 indicates that the asset is overbought, while below 30 indicates that it is oversold. The second important signal is divergence — a discrepancy between the price direction and the RSI line, which can indicate a trend reversal. The third signal is the crossing of the central line, when the RSI line crosses the 50 level, which may indicate a trend change. Finally, RSI can form support and resistance levels similar to the price chart. It is important to note that to increase accuracy and reduce the risk of false signals, RSI should be used alongside other analytical tools.

Advanced RSI Indicator Settings

The standard RSI settings can be modified to adapt to various trading styles. The default indicator period is 14, but it can be shortened to 7 for short-term trading or increased to 21 or more for long-term strategies. The standard overbought/oversold levels (70/30) can be changed to more extreme (80/20) for stronger signals. Additionally, the effectiveness of the RSI is enhanced when combined with additional indicators such as moving averages (SMA) or the stochastic oscillator. This parameter adjustment allows for the optimization of the RSI for specific trading strategies and market conditions.

Strategies for Using RSI

Professional traders use several basic strategies based on RSI. The divergence strategy focuses on finding discrepancies between price and RSI to identify potential trend reversals. The breakout strategy involves trading when breaking through overbought or oversold levels. The reversal strategy consists of opening positions when the RSI reverses from extreme levels. All these approaches require practice and adaptation to current market conditions, and should also be used in conjunction with other technical analysis methods to enhance the accuracy of trading signals.