RSI (Relative Strength Index): calculation, settings and how to read it

What it measures

RSI compares the average size of recent up moves against the average size of recent down moves and expresses the result on a 0–100 scale. It is a measure of momentum, not of value: a reading of 80 says buying has dominated recently, not that price is too high.

Because both averages are smoothed, RSI responds to the balance of pressure over a window rather than to any single bar.

How it is calculated

These are the steps Basis performs, verified against the published definition.

1. 1

   Take the bar-to-bar change in the source price and split it into gains and losses.

2. 2

   Smooth both series with Wilder’s method — a running average using 1/period rather than the 2/(period+1) of an exponential average.

3. 3

   Divide the average gain by the average loss to get relative strength.

4. 4

   Map it onto 0–100 with 100 − 100 / (1 + RS). An unbroken run of up-bars drives average loss to zero, where the reading is 100 rather than undefined.

Settings

Fourteen periods is the original setting and remains the most widely watched, which is itself a reason to keep it — a level everyone can see is a level that gets traded. Shortening it to 7 makes the indicator far noisier; lengthening it to 21 makes divergence easier to read at the cost of lateness.

How to read it

• Above 70 and below 30 mark unusual momentum, not reversals. In a strong trend RSI can hold above 70 for weeks, and selling every touch of it is the most common way to lose money with this indicator.
• The 50 line is more useful than the extremes: staying above it through pullbacks is a trend that is still intact.
• Divergence — price making a new high while RSI does not — says the new high was made with less momentum. It is a warning, not a trigger, and it can persist for a long time.
• On a range, the extremes work far better than they do on a trend, which is why RSI should be read alongside something that tells you which of the two you are in.

Where it misleads

Related indicators