Purpose and Calculation

RSI helps traders:

• Identify overbought and oversold market conditions.

• Detect potential trend reversals.

• Confirm momentum shifts in prices.

The RSI typically uses a 14-day window, calculated with the following formula:

Where RS (Relative Strength) is the average of gain over the average of loss during the specified period (usually 14 days).

Chart Walkthrough:
AAPL Price with RSI

The provided chart illustrates Apple's stock price (AAPL) alongside the RSI:

• RSI Line: The yellow line represents the 14-day RSI, fluctuating between 0 and 100.

• Overbought Threshold (70): When the RSI crosses above 70, it indicates potential overbought conditions, suggesting the price might be due for a correction or reversal.

• Oversold Threshold (30): When the RSI dips below 30, it signifies potential oversold conditions, hinting at a possible rebound or upward reversal.

Interpretation:

From the chart:

• Notice how when RSI crosses above 70, the stock often experiences downward corrections shortly thereafter.

• Similarly, when RSI dips below 30, price often stabilizes and rebounds, indicating buying opportunities.

Practical Applications

Traders typically apply RSI in the following strategic contexts:

• Trend Following: Validate the direction and persistence of a trend.

• Momentum Trading: Detect strong moves and anticipate possible reversals.

Example RSI Signals:

• Bullish RSI Oversold Rebound
  RSI dips below 30, then turns upward and re‑crosses the level—signalling renewed buying pressure.

• Bearish RSI Overbought Reversal
  RSI rallies above 70, flattens, and rolls over—warning that upward momentum is stalling.

• Bullish RSI Divergence
  Price prints a lower low while RSI forms a higher low, revealing hidden strength that can precede an upside reversal.

• Bearish RSI Divergence
  Price hits a higher high but RSI produces a lower high, hinting at momentum exhaustion before a downside move.

Best Practices:

• Customize the RSI parameter according to market volatility. For highly volatile stocks, shorter windows (7-10 days) might provide quicker signals.

• Always use RSI alongside additional indicators or price patterns for confirmation.

• Pay attention to RSI divergences (price moving opposite RSI), as these can strongly indicate upcoming trend reversals.

Limitations:

• RSI can remain overbought or oversold for extended periods during strong trends, producing premature signals.

• Short‑term spikes in volatile markets may push RSI to extremes without meaningful trend change.

By integrating RSI into a broader toolkit, traders can sharpen entries and exits while avoiding many of the false positives that isolated RSI readings may generate.