RSI (Relative Strength Index)

The most popular oscillator -- Wilder's smoothing, 70/30 levels, divergence, and why overbought does not mean sell.

What is the Relative Strength Index?

The Relative Strength Index (RSI) is an oscillator that measures the speed and magnitude of recent price changes on a scale from 0 to 100. It answers the question: of the recent candle-to-candle moves, how much was upward versus downward?

When nearly all recent moves have been up, RSI climbs toward 100. When nearly all have been down, it drops toward 0. A value near 50 means recent gains and losses have been roughly balanced.

RSI is the most widely used oscillator in technical analysis. It was developed by J. Welles Wilder in 1978 and remains the default choice for measuring whether a price move is overextended.

How It's Calculated

RSI is built in two steps. First, calculate the average gain and average loss over the last N candles. Then, convert the ratio of gains to losses into a 0-100 scale.

Relative Strength (RS)

RS = average gain / average loss

RSI

RSI = 100 - (100 / (1 + RS))

In plain English: look at the last N candles. For each candle that closed higher than the previous one, record the gain. For each candle that closed lower, record the loss. Average the gains and average the losses separately. Divide the average gain by the average loss to get the Relative Strength (RS). Then plug RS into the formula to get a number between 0 and 100.

Wilder's smoothing

Simula uses Wilder's smoothing method (the industry standard) to calculate the running average. After the initial seed (which uses a simple average of the first N candles), each subsequent average is updated as: new average = (previous average * (N-1) + current value) / N. This is equivalent to an exponential moving average with a smoothing factor of 1/N, and it produces the smooth RSI curve you see on charts. It is Wilder's original definition of RSI.

The 70/30 Levels

The standard interpretation uses two threshold levels:

Above 70 (overbought)

The average gain over the lookback period has been much larger than the average loss. The price has been rising aggressively relative to recent candles. This does not mean the price will reverse -- it means the upward momentum is elevated.

Below 30 (oversold)

The average loss has been much larger than the average gain. The price has been falling aggressively. Again, this signals intensity, not a guaranteed reversal.

Near 50

Recent gains and losses are roughly balanced. No strong directional momentum in either direction.

Overbought does not mean sell

This is the single most important thing to understand about RSI. During a strong uptrend, RSI can stay above 70 for weeks or months. Selling every time RSI crosses 70 would have you repeatedly exiting profitable positions. Overbought means "momentum is strong" -- what you do with that information depends on the market context and your strategy.

RSI Divergence

Divergence is considered a more reliable RSI signal than simple overbought/oversold readings. It occurs when the price and RSI disagree about the direction of momentum:

Bearish divergence

The price makes a higher high, but RSI makes a lower high. The price is still rising, but the momentum driving it is fading. This can precede a reversal or pullback.

Bullish divergence

The price makes a lower low, but RSI makes a higher low. The price is still falling, but the selling momentum is weakening. This can precede a bounce or trend reversal.

Divergence signals are not immediate -- the price can continue in its original direction for many candles after divergence appears. Think of divergence as an early warning, not a timing signal.

Period Settings

The default RSI period is 14 candles, which is what Wilder originally recommended. Simula allows periods from 5 to 100.

Short periods (5-9)

More sensitive, reaches overbought/oversold levels more frequently. Produces more signals but also more false signals. Used for short-term trading on lower timeframes.

Standard period (14)

The most widely used setting. Provides a balance between sensitivity and reliability. This is what most traders and platforms default to.

Long periods (20-50)

Smoother, reaches extreme levels less frequently. Each signal is potentially more significant because it takes a more sustained move to push RSI to an extreme. Used for swing trading or as a background filter.

Choosing a period

The right period depends on your timeframe and trading style. Rather than guessing, parameter optimization can test different RSI periods systematically against your specific asset and strategy.

RSI vs Stochastic

Both are oscillators on a 0-100 scale, but they measure different things. RSI measures the ratio of gains to losses -- it answers "how strong is the recent momentum?" The Stochastic measures where the close sits within the recent range -- it answers "where did the price close relative to its recent high and low?"

RSI can be overbought while Stochastic is not (and vice versa) because they respond to different aspects of price action. Using both together can provide confirmation, but be aware that they will sometimes disagree -- and disagreement is information, not an error.

Things to Watch Out For

In a strong uptrend, RSI frequently stays above 50 and can hover in the 60-80 range for extended periods. Treating every touch of 70 as a sell signal fights the trend. Some traders adjust by using higher thresholds (80/40 instead of 70/30) during confirmed uptrends and lower thresholds (60/20) during downtrends.

Where to Go Next

Stochastic Oscillator -- a different approach to measuring overbought/oversold.

CCI (Commodity Channel Index) -- an unbounded oscillator for measuring deviation from the mean.

Oscillators Overview -- all 8 oscillator types available in Simula.

Mean Reversion -- strategies built around oscillator signals.