RSI: The trading tool from zero to mastery

Many people want to chase every price rise and fall, but end up getting trapped once they do. Where’s the problem? Because you can’t accurately judge when to buy and when to sell. That’s when RSI (Relative Strength Index) comes in handy.

What exactly is RSI?

RSI stands for Relative Strength Index. In Chinese, it’s called 相对强弱指数. Simply put, it measures the strength of closing prices during an upward trend over a period, compared to the strength of closing prices during a downward trend. Through this comparison, RSI helps you quickly identify two key signals:

When should I sell? When RSI ≥ 70, the asset is in an “overbought” state, and the price may decline.

When should I buy? When RSI ≤ 30, the asset is in an “oversold” state, and the price may rise.

The beauty of RSI is that it compresses all data into a 0-100 range, allowing you to instantly see whether the market is hot or cold.

How is RSI calculated? (You can skip if you don’t want to see the details)

If you just want to use it without understanding the underlying principle, you can skip this part. For those interested, remember this formula:

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

where RS = average gain over a period ÷ average loss over the same period

The standard parameter is 14 periods, but you can also use 6, 12, 24 periods, adjusting based on your trading frequency. Shorter periods respond more sensitively; longer periods produce more stable signals.

How to profit from overbought and oversold signals?

Knowing about overbought and oversold isn’t enough. The key is to distinguish when these signals are real and when they are false.

Take Tesla(NASDAQ: TSLA) as an example. In May 2019, RSI dropped below 30 into oversold territory. You might think a rebound is coming, but waiting for just the signal isn’t enough. The real buy signal appears when RSI returns to the normal range and the price breaks through the previous downtrend line. That’s the true opportunity.

Conversely, in October 2021, Tesla hit a new high and RSI rose above 70 into overbought territory. You might think it’s time to sell, right? Not necessarily. This time, the difference was that RSI failed to make a new high while the price was still making new highs. This “divergence” is a warning sign—the market’s buying momentum is weakening, and a decline is imminent. Sure enough, it fell in December.

Using the RSI 50 midline to judge trend strength

This is a technique many overlook. The RSI 50 midline helps you determine whether the trend is truly established.

Look at Meta Platforms(NASDAQ: META) as an example. From March 2020, after RSI rebounded from oversold, it oscillated between 50 and 70. What does this indicate? It shows the uptrend is healthy. As long as RSI doesn’t drop below 50, hold your position.

But by mid-2021, problems appeared—RSI started bouncing around near 50, and although the price was still making new highs, this signal indicated: “Buddy, the fuel is running out.” Soon after, the price started to decline.

Core logic:

• RSI between 50-70: healthy uptrend, continue long
• RSI between 30-50: healthy downtrend, continue short
• RSI crossing below 50: trend reversal imminent, be alert

The strongest buy/sell signal: divergence

If overbought and oversold are “necessary conditions,” then divergence (divergence) is the “sufficient condition.” Meeting both greatly increases success probability.

What is divergence? Price makes a new high, but RSI makes a lower high; or price makes a new low, but RSI makes a higher low. This inconsistency is called divergence.

For example: Broadcom(NASDAQ: AVGO) at the end of 2022, the price kept making new lows, but RSI lows were rising. What does this indicate? Although the price is falling, the downward momentum is weakening, and market bottom-fishing strength is increasing. The result? The price rebounded.

Another example is Disney(NYSE: DIS). In mid-2021, the price hit a new high, but RSI’s high was lower. This is a bearish divergence, indicating the upward momentum is waning. Over the following year, the price kept falling.

Using MACD to “strengthen” RSI signals

RSI has a weakness—false signals in highly volatile markets. How to fix this? Use MACD together.

For example, Block Inc.(NYSE: SQ). When RSI just dropped from overbought territory, you might hesitate to short. At this point, check MACD: if MACD line also crosses below the signal line, it confirms the short signal. This makes the signal more reliable.

Practical checklist

When to go long:

1. RSI ≤ 30 enters oversold
2. RSI rebounds into the normal range
3. Price breaks above the previous downtrend line

When to go short:

1. RSI ≥ 70 enters overbought
2. RSI falls back into the normal range
3. Price breaks below the previous uptrend line

Additional tips:

• Divergence between price and RSI (most powerful signal)
• Other indicators like MACD also confirm the same direction

Finally, a reminder: RSI is just a tool, not a magic wand. Its main role is to help you make decisions at the right time, but the trend direction still depends on your chart analysis. Indicators are auxiliary; the trend is king.