RSI (Relative Strength Index)

RSI uses a two-step calculation developed by J. Welles Wilder Jr. in 1978.

Step 1 — Calculate Average Gain and Average Loss over the lookback period (default 14). For each bar, if the close is higher than the prior close, the gain equals the difference and the loss is zero. If the close is lower, the loss equals the absolute difference and the gain is zero. Sum all gains and all losses over 14 periods and divide each by 14.

Step 2 — Calculate RS and RSI:

• RS (Relative Strength) = Average Gain / Average Loss
• RSI = 100 − (100 / (1 + RS))

After the initial 14-bar calculation, subsequent values use Wilder's smoothing: Average Gain = ((Previous Avg Gain × 13) + Current Gain) / 14. This makes RSI an exponentially weighted metric — recent price changes matter more than older ones.

Example: Over 14 days a stock posts gains of $1.20, $0.80, $0.50 on 7 up days (avg gain $0.36/day) and losses of $0.70, $1.00, $0.40 on 7 down days (avg loss $0.30/day). RS = 0.36/0.30 = 1.20. RSI = 100 − (100/2.20) = 54.5 — neutral momentum.

Beginners treat 70/30 as automatic buy/sell signals. Experienced traders know RSI is far more nuanced.

Divergence trading — The highest-probability RSI setup. Bullish divergence: price makes a lower low but RSI makes a higher low, signaling sellers are losing steam. Bearish divergence: price makes a higher high but RSI makes a lower high, signaling buyer exhaustion. Divergences often precede reversals by 2-5 bars.

RSI range shifts — In a strong uptrend, RSI oscillates between 40 and 80 (not 30 and 70). In a strong downtrend, it oscillates between 20 and 60. Adjust your levels to the trend: buy pullbacks to RSI 40-50 in bull trends instead of waiting for 30.

Failure swings — A bullish failure swing: RSI falls below 30, bounces, pulls back but stays above 30, then breaks its prior RSI high. This is a pure momentum signal that doesn't require price confirmation. Wilder considered failure swings his most reliable RSI signal.

RSI with VWAP — For day trading, combining RSI(14) on a 5-minute chart with VWAP creates a powerful filter: only take long entries when price is above VWAP AND RSI is recovering from below 40. This filters out counter-trend noise.

The RSI period controls sensitivity vs. smoothness.

RSI(7): More responsive, crosses 70/30 more frequently. Preferred by day traders and scalpers on 1-5 minute charts. Generates more signals but also more false positives. Best for short-term momentum trades where quick entries matter.

RSI(14): Wilder's original setting. The benchmark that most trading platforms default to and most educational material references. Balances signal quality with frequency. Works well on daily and 15-minute charts.

RSI(21): Smoother, fewer signals, higher reliability per signal. Preferred by swing and position traders. On a daily chart, RSI(21) reaching 30 is a much rarer event than RSI(7) reaching 30 — and statistically more meaningful as a reversal signal.

Connors RSI: A composite indicator combining RSI(3), a streak RSI (consecutive up/down day count), and a percentile rank of rate-of-change. Developed by Larry Connors for mean reversion strategies on daily charts. Extremely short-term — best for 1-5 day holding periods.

Mistake 1: Using RSI as a standalone signal — RSI 30 doesn't mean "buy" in isolation. A stock can have RSI 20 and keep falling for weeks in a strong downtrend. Always combine RSI with trend context (VWAP, moving averages) and volume confirmation.

Mistake 2: Same levels for every stock — Growth stocks like NVDA or TSLA frequently operate with RSI above 60 during rallies. Using 70 as an automatic sell trigger would have you exiting every rally prematurely. Adjust levels based on the stock's historical RSI range.

Mistake 3: Ignoring the timeframe — RSI 30 on a weekly chart is a much more significant event than RSI 30 on a 5-minute chart. Multi-timeframe RSI analysis (weekly RSI bullish + daily RSI pulling back to 40) produces more reliable signals than any single timeframe.

Mistake 4: Confusing oversold with undervalued — RSI measures price momentum, not fundamental value. A stock can be RSI 15 because the company reported fraud. Oversold is a momentum concept, not a value concept.