Module 6B: Indicators · Lesson 2 of 10 · Back to course
The Relative Strength Index, or RSI, is probably the most widely used momentum indicator. It’s on every platform, it’s simple to read, and it’s also one of the most misunderstood. This lesson explains what it measures, how it’s calculated, and why “RSI is over 70, so sell” is a rule that has emptied plenty of accounts.
What it is
RSI is a momentum oscillator. It compares the size of recent up-moves with the size of recent down-moves and turns the result into a number between 0 and 100. It was introduced by J. Welles Wilder in 1978, and the standard setting is 14 periods – 14 candles on whatever timeframe you’re using.
- A reading above 50 means recent gains have been bigger than recent losses.
- A reading below 50 means recent losses have been bigger than recent gains.
- Readings above 70 are traditionally called “overbought” and readings below 30 “oversold”.
Those last two labels are the source of most RSI mistakes, so we’ll come back to them.
How it’s calculated (in plain English)
You’ll never need to calculate RSI by hand – your platform does it – but knowing what goes into it helps you understand what it can and can’t tell you.
- For each of the last 14 candles, look at the change from the previous close. If price closed higher, that’s a gain. If it closed lower, that’s a loss (recorded as a positive number).
- Work out the average gain and the average loss over those 14 candles. (After the first calculation, Wilder’s method smooths these averages so each new candle only nudges them a little.)
- Divide the average gain by the average loss. This is called RS (relative strength).
- Convert it to a 0–100 scale: RSI = 100 − (100 ÷ (1 + RS)).
If gains and losses are equal, RS is 1 and RSI is 50. If there have been no losses at all, RSI heads towards 100. If there have been no gains, it heads towards 0.
Notice what’s not in the formula: support and resistance, the trend on a higher timeframe, news, or anything about the future. RSI only knows how big the recent close-to-close moves were.
How traders use it
1. As a momentum gauge, not a reversal signal. In a strong uptrend, RSI can sit above 70 for a long time. Many traders read a high RSI as a sign of strong buying, not as a reason to sell.
2. The 50 line as a trend filter. Some traders only look for buys while RSI is above 50 and only look for sells while it’s below 50. It’s a simple way of checking that momentum agrees with the direction you’re trading.
3. Pullbacks within a trend. In an uptrend, a dip in RSI towards 40–50 (rather than all the way to 30) can show a pullback losing steam. This is similar in spirit to the Moving Average Pullback Strategy.
4. Ranges. In a clearly sideways market, readings near 70 and 30 more often line up with the top and bottom of the range. This is where the classic “overbought/oversold” reading works best – and it stops working the moment the range breaks. Combine it with clear levels, as in the Support and Resistance Bounce Strategy.
5. Divergence. When price makes a new high but RSI makes a lower high, momentum is fading. That’s a warning, not a sell signal. We cover it properly in Lesson 6B.9.
Common mistakes
- Selling just because RSI is above 70 (or buying because it’s below 30). In trends, these readings can last a long time while price keeps going.
- Ignoring the timeframe. RSI on a 5-minute chart can be “overbought” while RSI on the daily chart is neutral. Decide in your plan which timeframe counts.
- Changing the period to fit the chart. A 7-period RSI that “caught” last week’s turns is curve-fitting. Stick to 14 while you learn.
- Using RSI with Stochastic and CCI as “confirmation”. They’re all momentum oscillators, so they agree with each other most of the time (see Lesson 6B.10).
- Forgetting the stop. An RSI reading is never a reason to trade without a stop-loss or with a bigger position.
Example (illustrative numbers)
All figures are made up for teaching purposes. They aren’t real prices or a trade idea.
Suppose over the last 14 one-hour candles on GBP/USD:
- the average gain on up-candles works out at 6 pips
- the average loss on down-candles works out at 4 pips
Then:
- RS = 6 ÷ 4 = 1.5
- RSI = 100 − (100 ÷ (1 + 1.5)) = 100 − 40 = 60
A reading of 60 says recent gains have outweighed recent losses, but not dramatically. Now imagine the next few candles are strong up-candles and RSI rises to 74. A beginner might see “overbought” and sell. A trader with a written plan would ask different questions:
- Is the higher timeframe trending up? If so, a high RSI may just reflect that trend.
- Is price at a clear resistance level? If not, there’s no particular reason to expect a turn here.
- Does my plan even include counter-trend trades? If not, the RSI reading is just information.
The prop firm angle
RSI doesn’t help you pass a challenge, but misreading it can help you fail one. Repeatedly selling “overbought” readings in a trending market produces a run of losses against the trend – exactly the kind of streak that runs into a daily loss limit. If you use RSI in a challenge:
- Use it as a filter that keeps you trading with momentum, not against it.
- Never let a reading justify a bigger position or a wider stop than your plan allows.
- Write down in advance what RSI condition, if any, is part of your setup – and test it on demo first (Module 13).
Key takeaways
- RSI compares average gains with average losses over (usually) 14 candles and plots the result from 0 to 100.
- Above 50: gains have been bigger. Below 50: losses have been bigger.
- “Overbought” and “oversold” describe the past. In trends, they can last a long time.
- Most traders use RSI as a momentum filter or a context tool, not as an automatic reversal signal.
Quick quiz
- What does an RSI reading of exactly 50 tell you? (Average gains and average losses over the period are equal.)
- If the average gain is 3 and the average loss is 3, what is RS? (1.)
- If the average gain is 8 and the average loss is 2, what is RSI? (RS = 4, so RSI = 100 − 100 ÷ 5 = 80.)
- Why is “RSI above 70, so sell” risky in a strong uptrend? (RSI can stay above 70 for a long time while price keeps rising.)
- In which kind of market do overbought/oversold readings tend to line up best with turning points? (A clear sideways range.)
Key terms
RSI · Momentum oscillator · Overbought · Oversold · Divergence · Range · Also see Trading jargon in plain English.
Try this
On a demo or free charting account, add RSI(14) to a daily chart of the FTSE 100. Scroll back and find three times RSI went above 70. For each one, note what price did over the next 10 candles. Then do the same for three readings below 30. Write down how many “overbought” readings were followed by a fall and how many by further gains. Six examples prove nothing either way – the point is to see for yourself that the label isn’t a forecast.
FAQ
What are the best RSI settings? The default of 14 is what most traders and lessons use. Shorter settings make RSI jumpier; longer ones make it smoother. Changing settings to fit recent charts is curve-fitting.
Does RSI work on forex, indices and shares? It can be calculated on any market with prices. How useful it is depends on how you use it, not on the market.
Is RSI a leading or lagging indicator? It’s calculated from past closes, so it lags. It can show momentum fading before price turns, but momentum can also fade without a turn.
Disclaimer: This page is general education, not financial or investment advice or a personal recommendation, and it doesn’t take your circumstances into account. Examples are hypothetical, for illustration only, and not an invitation to buy or sell. Learning a strategy doesn’t guarantee profits. Past performance is not a reliable guide to future results. Futures, spread bets and CFDs are complex and carry a high risk of losing money quickly because of leverage, and most retail traders lose money. With a real futures account, losses can exceed your deposit. Only trade with money you can afford to lose, and speak to an independent FCA-authorised adviser if you’re unsure. Read our full risk warning.