What is RSI? Definition, Formula, and Example
RSI (Relative Strength Index) is a momentum oscillator that measures the speed and magnitude of recent price changes on a 0–100 scale, signaling overbought conditions above 70 and oversold conditions below 30.
What is RSI (Relative Strength Index)?
RSI (Relative Strength Index) is a momentum oscillator developed by J. Welles Wilder Jr. in 1978 that measures the speed and magnitude of recent price changes. It produces a single value between 0 and 100. Readings above 70 indicate overbought conditions; readings below 30 indicate oversold conditions. It is one of the most widely used technical indicators in equity, futures, and forex markets.
RSI Formula and Calculation
RSI uses a two-step calculation over a default 14-period lookback:
Step 1 — Initial values:
Average Gain = Sum of gains over 14 periods / 14
Average Loss = Sum of losses over 14 periods / 14
RS = Average Gain / Average Loss
RSI = 100 − [100 / (1 + RS)]Step 2 — Smoothed subsequent values (Wilder smoothing):
Average Gain = [(Prior Avg Gain × 13) + Current Gain] / 14
Average Loss = [(Prior Avg Loss × 13) + Current Loss] / 14The smoothing prevents abrupt jumps and makes RSI relatively stable once the lookback window is seeded.
Worked Example: AAPL
Take AAPL over 14 trading days. Suppose 9 days closed up with an average gain of $1.40 and 5 days closed down with an average loss of $0.70.
Average Gain = (9 × $1.40) / 14 = $0.90
Average Loss = (5 × $0.70) / 14 = $0.25
RS = $0.90 / $0.25 = 3.60
RSI = 100 − [100 / (1 + 3.60)] = 100 − 21.74 = 78.26An RSI of 78.26 is firmly in overbought territory. A momentum trader watching this reading would begin watching for bearish divergence or a pullback to the 50-line as a potential exit signal.
When Traders Use RSI
Swing traders use RSI to time entries against the dominant trend: a pullback to RSI 40–50 in an uptrend is a higher-probability re-entry point than chasing strength at 75. Day traders shorten the lookback — RSI-7 or RSI-9 on 5-minute charts — to generate faster signals. Divergence setups are among the most powerful RSI applications: when price makes a new high but RSI prints a lower high, momentum is weakening and a reversal is more probable. The same logic applies in reverse for bullish divergence at lows.
Limitations and Misconceptions
RSI does not determine direction on its own — it describes momentum, not trend. In a sustained uptrend, RSI can remain above 70 for weeks. Selling NVDA every time RSI hit 70 during 2023 would have produced a series of losing short trades as the stock tripled. The 70/30 thresholds are not universal laws: traders commonly use 80/20 for highly volatile assets to reduce false signals. RSI is also useless in isolation on illiquid instruments where price gaps repeatedly distort the smoothed averages.