Relative Strength Index (RSI) is a momentum oscillator that measures the speed and magnitude of price changes in forex markets. It ranges from 0 to 100 and helps traders identify potential reversal points and overbought/oversold conditions.
RSI is calculated using the formula: RSI = 100 - (100 / (1 + RS)), where RS is the ratio of average gains to average losses over a specific period, typically 14 periods. The indicator is plotted as a line oscillating between 0 and 100.
RSI identifies two key trading conditions. Values above 70 suggest overbought conditions, indicating potential downward price reversals or pullbacks. Values below 30 suggest oversold conditions, indicating potential upward price reversals. Traders use these levels as signals to enter or exit positions.
RSI also reveals divergence—mismatches between price trends and momentum. Bullish divergence occurs when RSI makes higher lows while prices make lower lows, suggesting an upcoming upward reversal. Bearish divergence occurs when RSI makes lower highs while prices make higher highs, suggesting a downward reversal.
However, RSI has limitations. It can generate false signals, especially in ranging or choppy markets, and overbought/oversold levels can persist longer than expected. RSI works best when combined with other technical indicators and fundamental analysis.
