RSI Indicator Explained: Overbought, Oversold and Divergence
The Relative Strength Index (RSI) measures how strong recent gains are compared with recent losses, on a scale from 0 to 100. It is one of the most useful momentum indicators, and one of the most misused.
How RSI is calculated
RSI compares the average gain with the average loss over a period, usually 14 candles. When gains dominate it rises towards 100; when losses dominate it falls towards 0. The standard settings, created by J. Welles Wilder, are 14 periods with levels at 30 and 70.
Overbought and oversold
Above 70 is called overbought and below 30 oversold. These are warnings that the move is stretched, not automatic reversal signals. In a strong uptrend RSI can stay above 70 for weeks; selling every time it crosses 70 means fighting the trend.
The 50 line
A simple and robust use: RSI above 50 means momentum favours buyers, below 50 favours sellers. Many trend traders only buy pullbacks while RSI holds above 40-50, and only short while it stays below 50-60.
Divergence
Bearish divergence: price makes a higher high but RSI makes a lower high, so momentum is fading. Bullish divergence is the reverse. Divergences can last a long time, so wait for price to confirm, for example by breaking a trendline.
Common mistakes
- Shorting just because RSI is above 70 in an uptrend
- Ignoring the bigger trend
- Acting on divergence without price confirmation
Free tools for this strategy
Risk/reward calculator · Position size calculator
Open the Risk/reward calculator →Frequently asked questions
What is a good RSI setting?
14 periods is the standard. Shorter settings (7-9) are more sensitive and give more signals, including more false ones.
Is RSI below 30 a buy signal?
Not on its own. It means selling has been intense. In a downtrend, RSI can stay oversold while price keeps falling. Look for confirmation and use a stop.