The Relative Strength Index (RSI) is a momentum oscillator used in technical analysis to measure the speed and change of price movements. It ranges from 0 to 100 and is typically used to identify overbought or oversold conditions in a market.
Here's how RSI works:
1. **Calculation:** RSI is calculated using the average of gains and losses over a specified period, often 14 periods. The formula is:
RSI = 100 -100 +Average Gain/Average Loss
- Average Gain: Average of all upward price changes over the selected period.
- Average Loss: Average of all downward price changes over the selected period.
2. **Interpretation:**
- **Overbought Conditions (High RSI):** When RSI is above 70, it is considered overbought. This suggests that the asset may be overvalued, and there is a possibility of a price reversal or correction.
- **Oversold Conditions (Low RSI):** When RSI is below 30, it is considered oversold. This indicates that the asset may be undervalued, and there could be a potential for an upward reversal.
3. **Divergence:** Traders also look for divergence between price and RSI. If the price makes a new high, but RSI fails to confirm it with a new high, it might indicate weakening momentum and a possible reversal.
4. **Trend Confirmation:** RSI can be used to confirm the strength of a trend. In a strong uptrend, RSI tends to stay in the overbought zone, and in a strong downtrend, it tends to stay in the oversold zone.
5. **Signal for Potential Reversals:** RSI crossovers, where the indicator moves above or below certain levels, can signal potential trend reversals.
As with any technical indicator, it's important to use RSI in conjunction with other analysis tools and not rely solely on it. False signals can occur, and market conditions may vary.
