Mastering the RSI Indicator from Scratch: Overbought/Oversold, Divergence Signals, and Diminishing Phenomena Explained

In the world of technical analysis, the RSI (Relative Strength Index) is one of the essential tools for investors to get started. Whether you’re a newcomer just entering the trading market or an experienced investor, understanding the core principles and applications of RSI can help you more accurately grasp entry and exit points.

So, how exactly is RSI calculated? Why does divergence occur? How can you respond to the frustrating issue of RSI becoming dull? How should you choose the rsi parameter setting days? This article will answer these questions one by one.

The Basic Principles of RSI (Relative Strength Index)

RSI (Relative Strength Indicator) primarily measures the strength comparison between buyers and sellers over a specific period. Simply put, it compares the magnitude of upward and downward price changes to determine market momentum.

Over the past decade, RSI has gradually become one of the most commonly used technical analysis tools among traders worldwide. Its popularity is straightforward: the calculation logic is intuitive and does not require complex mathematics. Compared to other indicators like MACD, RSI is easier for beginners to understand and master, which is why it often appears in the first lessons for investors.

On most trading platform charts, RSI is displayed alongside indicators like KD and MACD below the price chart, serving as an important reference for investors to decide whether to open or close positions.

The Calculation Logic and Numerical Meaning of RSI

To deeply understand RSI, you need to grasp its calculation method. Fortunately, the process is simple and involves basic arithmetic operations.

The calculation process is divided into three stages:

Step 1: Determine the statistical period and calculate average amplitude

Choose a time period (commonly defaulted to 14 days). Within this period:

• Sum all upward price changes and divide by 14 to get the “average upward change”
• Sum all downward price changes and divide by 14 to get the “average downward change”

Step 2: Calculate the Relative Strength (RS)

Divide the “average upward change” by the “average downward change” to obtain the relative strength value.

Step 3: Convert to RSI value

Use the formula: RSI = 100 - (100 ÷ (1 + RS))

The final RSI value ranges between 0 and 100.

Practical Methods for Setting RSI Parameter Days

The number of days set for the rsi parameter is a key factor influencing RSI sensitivity. Different period settings directly affect the indicator’s responsiveness and accuracy.

Standard parameters and adjustment principles:

The default 14-day period suits most medium-term investors, but traders can flexibly adjust based on their needs:

For short-term traders: Set rsi parameter days to 3, 5, or 7 days, making the RSI line more sensitive to market changes, allowing quick capture of short-term volatility opportunities. Under this setting, RSI will more frequently cross overbought and oversold zones.

For medium to long-term investors: Extend the period to 20, 30 days, or longer. RSI fluctuations will become smoother, filtering out short-term market noise and helping investors focus on medium to long-term trends.

Multi-period combination strategies: Many seasoned investors set multiple RSI lines with different periods (e.g., 6-day, 12-day, 24-day) and use their interactions to enhance the reliability of judgments.

The Three Major RSI Application Signals

Overbought and Oversold Zones: Reflection of Extreme Market Sentiment

RSI values are fixed between 0 and 100, with two critical zones:

Overbought zone (RSI > 70): When RSI breaks above 70, it indicates that the buying force is overly concentrated, and the stock price may undergo a correction. Holders should consider gradually reducing their positions.

Oversold zone (RSI < 30): When RSI drops below 30, it suggests that selling momentum is overextended, and the stock price may rebound. Investors can evaluate opportunities to enter positions gradually.

In advanced applications, some investors use RSI > 80 or RSI < 20 as more extreme overbought or oversold zones to catch clearer turning points.

RSI Divergence: Early Warning of Trend Reversal

Divergence is one of the most important RSI application techniques. It refers to the situation where the price makes a new high or low, but RSI fails to do so simultaneously. This discord often hints that a market reversal is imminent.

Top Divergence (Bearish Signal):

Price makes a new high, but RSI declines or fails to reach a new high. This indicates weakening upward momentum and potential selling pressure. For example, Bitcoin rises from $70,000 to $100,000, creating a new high, but RSI drops from 82 to 58. This divergence suggests the upward trend may face a correction, and holders should stay alert.

Bottom Divergence (Bullish Signal):

Price makes a new low, but RSI does not make a new low and instead stabilizes or rises. This usually means downward momentum is waning, and a rebound may be brewing.

It’s worth noting that during divergence formation, if RSI repeatedly fluctuates and crosses the 50 midline multiple times, it indicates the market is still in a consolidation phase without a clear divergence pressure. Investors should avoid premature actions.

50 Midline: The Boundary Between Bulls and Bears

The 50 midline of RSI represents the equilibrium point of buying and selling forces:

RSI > 50: Indicates that bullish strength is dominant, market sentiment is optimistic, and the trend is likely to continue upward.

RSI < 50: Indicates that bearish strength is dominant, market sentiment is pessimistic, and the trend may continue downward.

Investors can use the 50 midline as an important reference for trend direction, combined with trend lines and other indicators for confirmation.

Golden Cross and Death Cross: The Power of Multi-Period RSI

When investors use multiple RSI lines with different periods simultaneously, the crossovers between these lines generate strong trading signals.

Golden Cross: When a short-period RSI crosses above a long-period RSI, it indicates increasing upward momentum, often signaling a good time to establish new long positions.

Death Cross: When a short-period RSI crosses below a long-period RSI, it suggests accumulating downward pressure, and traders should consider closing positions or reducing risk exposure.

Additionally, when multiple RSI lines are below the 50 midline and form a “W” shape, it indicates weakening bearish forces and a potential rebound; an “M” shape suggests insufficient bullish momentum and possible decline.

Recognizing and Responding to RSI Dullness

RSI dullness is one of the most common challenges faced by users. It refers to RSI remaining in overbought (>70) or oversold (<30) zones for extended periods, with a noticeably reduced sensitivity to price movements.

This often occurs during strong trending markets. For example, in a robust uptrend, RSI may stay in the overbought zone for a long time, and even corrections may not push it below 70. In such cases, traditional signals like “overbought means sell” become invalid, yet prices continue to rise.

Four strategies to handle dullness:

1. Adjust RSI parameters

When dullness occurs frequently, changing the rsi parameter days is an effective quick fix. For example, shifting from 14 days to 10 or 20 days can alter the indicator’s sensitivity, making RSI respond faster or more stably to trend changes.

2. Combine with trend analysis tools

Do not rely solely on RSI. Use it alongside moving averages, volume, MACD, and other indicators to verify signals and avoid false positives caused by single-indicator reliance.

3. Wait for clear reversal confirmation

Even if RSI is in extreme zones, patiently wait for other indicators or price structures to confirm a reversal rather than rushing into action. Divergence in strong trends can persist for a long time, and premature entries may lead to losses.

4. Enforce strict risk management

During dull periods, setting reasonable stop-loss points becomes crucial. Avoid blindly chasing highs or selling lows, and control risk exposure per trade to protect your capital.

Practical Application Framework for RSI

Integrate all elements of the RSI indicator into a complete trading framework:

Step 1: Observe the trend

Use moving averages or trend lines to determine the main market direction, then use RSI for auxiliary confirmation.

Step 2: Look for divergence signals

In clear upward or downward trends, monitor RSI for divergence. Divergence often signals an impending reversal.

Step 3: Confirm bullish or bearish shifts

When RSI crosses the 50 midline, confirm the change in buying or selling strength with volume and other indicators.

Step 4: Manage positions

In overbought or oversold zones, combine divergence signals and risk management principles to decide whether to reduce, close, or add to positions.

Summary

Although RSI (Relative Strength Index) is simple to calculate, its applications are rich and nuanced. Mastering overbought and oversold zones, divergence signals, the 50 midline, and strategies to handle dullness are fundamental for becoming a mature investor.

Remember, no indicator is perfect. The greatest value of RSI lies in helping investors identify extreme market emotions and potential turning points. Ultimately, trading decisions should also consider market environment, capital management, and psychological resilience. By repeatedly practicing different rsi parameter setting days on demo accounts, investors can gradually find the most suitable settings for their trading style, thereby improving overall trading success rate.