The relative strength index (RSI) is a momentum indicator used in technical analysis to evaluate overvalued or undervalued conditions in the price of a security. Developed by J. Welles Wilder Jr. and introduced in his 1978 book, the RSI is displayed as an oscillator on a scale of zero to 100.
Traditionally, an RSI reading of 70 or above indicates an overbought situation, while a reading of 30 or below indicates an oversold condition. However, it can also indicate securities that may be primed for a trend reversal or corrective pullback in price. By comparing a security's strength on days when prices go up to its strength on days when prices go down, the RSI can give traders an idea of how a security may perform.
When used in conjunction with other technical indicators, it can help traders make better-informed trading decisions. However, it is important to understand the primary trend of the security to properly understand RSI readings. Some traders will create a horizontal trendline between the levels of 30 and 70 to better identify the overall trend and extremes.
Additionally, the RSI is not as reliable in trending markets as it is in trading ranges and false signals often generated during trending markets. A related concept is to use trade signals and techniques that conform to the trend, such as using bullish signals primarily when the price is in a bullish trend and bearish signals primarily when a stock is in a bearish trend, to avoid false alarms. An RSI divergence occurs when price moves in the opposite direction of the RSI, a change in momentum before a corresponding change in price.