RSI explained: momentum, overbought and oversold

The Relative Strength Index (RSI) is a momentum oscillator that compares the size of a stock's recent gains with the size of its recent losses and expresses the result on a scale from 0 to 100. It was introduced by J. Welles Wilder Jr. in 1978 and remains one of the most widely used indicators. It is useful for judging how stretched a move is, but readings such as "overbought" are easy to misinterpret.

The formula

RS  = average gain over N periods / average loss over N periods
RSI = 100 - 100 / (1 + RS)

The standard setting is N = 14 periods, most often 14 days. Gains and losses are measured from one close to the next. On an up day the gain is the price change and the loss is zero; on a down day it is the other way around. After the first 14 periods, Wilder's method smooths the averages: each new average equals the previous average times 13, plus the new value, all divided by 14. Because of that smoothing, RSI values can differ slightly between platforms that use a plain average instead.

Some properties follow directly from the formula. RSI is 50 when average gains equal average losses. It approaches 100 when losses nearly vanish, and 0 when gains nearly vanish. Because it is bounded, it is easy to compare across stocks, unlike many unbounded indicators.

Example (illustrative numbers)

Suppose that over 14 days a stock's average daily gain (counting down days as zero gain) is $0.60 and its average daily loss (counting up days as zero loss) is $0.40.

RS  = 0.60 / 0.40 = 1.5
RSI = 100 - 100 / (1 + 1.5) = 100 - 40 = 60

Now suppose a weaker stretch where the average gain is $0.20 and the average loss is $0.60:

RS  = 0.20 / 0.60 = 0.333
RSI = 100 - 100 / 1.333 = 100 - 75 = 25

An RSI of 60 says gains have outweighed losses moderately. An RSI of 25 says losses have clearly dominated.

How to read RSI

The conventional reference levels are:

The labels describe recent speed, not value. A stock with an RSI of 75 is not necessarily too expensive, and one with an RSI of 25 is not necessarily cheap. Valuation is a separate question covered by fundamental analysis, for example in the price-to-earnings ratio.

Rules of thumb that practitioners use:

• The 50 line. An RSI that stays above 50 suggests buyers have had the upper hand; staying below 50 suggests sellers have.
• The trend changes the range. In strong uptrends, RSI often stays roughly between 40 and 80 and rarely reaches 30. In strong downtrends, it often stays roughly between 20 and 60. If that holds, a reading of 70 in an uptrend is routine rather than a warning, and a dip to 40 can be a normal pullback.
• Stocks can stay overbought. In a persistent trend, RSI can stay above 70 for weeks. Selling every time it crosses 70 means leaving a trend early.
• Settings are adjustable. A shorter period (such as 7 or 9) swings more widely and produces more signals; a longer one is calmer. Some readers use 80 and 20 instead of 70 and 30 for volatile stocks.
• Divergence. When price makes a new extreme but RSI does not, momentum may be fading. This is covered in RSI divergence.

Common mistakes and limits

• Treating overbought as a sell signal. The label means the move has been rapid, not that it must reverse.
• Treating oversold as a buy signal. A stock can fall for a long time while RSI sits below 30. Falling prices can have a real cause, such as a poor earnings report, that a momentum reading cannot see.
• Ignoring the trend. The same reading means different things in a rising market and a falling one. Check the direction first, using tools like moving averages.
• Using it alone. RSI measures only closing-price momentum. It ignores volume, news and the company's fundamentals.
• Confusing it with relative strength comparisons. Despite the name, RSI does not compare a stock with the market or with other stocks. It compares a stock's own gains and losses over time.

RSI is closely related to the stochastic oscillator, which asks a different question: where the latest close sits within the recent high-low range. RSI asks how large gains have been compared with losses.

Where to see it on StocksXray

The scanner includes an oversold preset and an undervalued and oversold preset that apply the oversold idea described here, and an RSI divergence preset. Stock pages show a price chart with indicators and a technical summary across daily, weekly and monthly time frames.

Key takeaways

• RSI = 100 - 100 / (1 + RS), where RS is average gain divided by average loss, usually over 14 periods.
• It is bounded between 0 and 100, with 70 and 30 as conventional overbought and oversold levels.
• Overbought and oversold describe the speed of recent moves, not whether a stock is expensive or cheap.
• In strong trends RSI can stay at an extreme for a long time, so read it in the context of the trend.
• It works best as one input alongside price structure and fundamentals.