Recently, someone asked me how to determine when to buy or sell a stock. I thought of a tool that many people use but beginners often overlook — the Relative Strength Index, or RSI.

Actually, the definition of RSI is very simple; it is a momentum oscillator used to measure the speed and magnitude of price changes over a certain period. This indicator was created by J. Welles Wilder, who was originally a mechanical engineer and later turned to technical analysis. RSI fluctuates between 0 and 100, and this range is very important.

According to Wilder’s traditional theory, an RSI above 70 indicates that the stock is overbought — meaning it is overvalued — which we call an overbought condition. Conversely, an RSI below 30 suggests oversold, meaning the price has been pushed down. But there is a detail: market conditions influence this judgment. In a bull market, RSI typically fluctuates between 40 and 90, but in a bear market, it often hovers between 10 and 60.

Talking about how to calculate RSI, it’s basically averaging the price gains and losses over the past 14 days. Sum all the upward price changes over the past 14 days and divide by 14 to get the average gain; do the same for all downward changes to get the average loss. Then, plug these two numbers into the formula: RSI = 100 – [100 / (1 + (average gain / average loss))]. It looks complicated, but modern trading software can calculate it automatically.

Personally, I pay attention to another use of RSI — divergence. When the stock price hits a new high but RSI makes a lower high, it’s called a bearish divergence, which may indicate that the upward momentum is weakening and the price could decline later. Conversely, if the stock hits a new low but RSI makes a higher low, it’s called a bullish divergence, suggesting a bottom may be forming and a rebound could occur. These divergence signals often give earlier warnings than the price itself.

In practical trading, I use RSI to find trading opportunities. For example, if a stock’s RSI is only 1, it indicates it is severely undervalued and might be a good buy point. On the other hand, if RSI approaches 95, the stock is clearly overbought, and it might be time to reduce holdings. But it’s important to emphasize that RSI is just a reference and should not be the sole basis for decision-making.

RSI also has its limitations. First, it only looks at price changes and cannot reflect major news, policy changes, or other significant events. Second, RSI is a lagging indicator; it measures past price movements, and past performance does not necessarily predict future results. Additionally, it uses a 14-day window, which may be too short to accurately assess long-term trends.

Therefore, RSI is most suitable for active traders who manage their portfolios frequently. If you are a long-term investor holding index funds, RSI’s reference value is less significant because index funds typically consist of hundreds or thousands of stocks, and their prices don’t fluctuate as dramatically. For such investors, a buy-and-hold strategy might be more appropriate.