RSI Indicator: A momentum measurement tool that traders really need to understand

Behind the Relative Strength Index

RSI indicator or Relative Strength Index was developed by J. Welles Wilder Jr. in 1978 as a technical analysis tool that measures the speed and magnitude of price changes. However, the common understanding of the RSI indicator is often distorted from its original purpose.

Novice traders often believe that RSI indicator signals price reversals, but in reality, professional traders use it for entirely different purposes.

The True Meaning of RSI Indicator

RSI indicator fundamentally is a momentum oscillator, not an asset valuation tool. It compares the average gains to the average losses over a specified period (Standard 14 bars).

The confusing name “Relative Strength” does not refer to comparing asset A to B, but rather to an internal comparison within the asset itself. If buying momentum is strong, RSI will run high; if selling momentum dominates, RSI will run low.

How to Calculate RSI Indicator

Although most trading platforms calculate RSI automatically, understanding the underlying formula will elevate your usage to a professional level.

Basic formula:

RS = Average Gain (AvgU) / Average Loss (AvgD)

• Average Gain (AvgU): The mean of all upward moves over 14 bars
• Average Loss (AvgD): The mean of all downward moves over 14 bars (Using positive values)

What to know from the formula:

When Average Gain > Average Loss, RSI > 50, indicating bullish momentum dominates.
When Average Gain < Average Loss, RSI < 50, indicating bearish momentum dominates.
When Average Gain = Average Loss, RSI = 50 — the equilibrium point.

This is the critical point where RSI is often misused. The 50 line is not just a balance; it also indicates who is controlling the market.

Common Misconceptions about RSI > 70 and RSI < 30

When first learning RSI, you often hear:

RSI > 70 (Overbought - Too many buyers): Suggests selling.
RSI < 30 (Oversold - Too many sellers): Suggests buying.

This sounds reasonable, but in reality, it can lead to significant losses.

The Problem with the 70/30 Strategy

In markets with strong trends (Strong Trend), RSI can stay above 70 or below 30 for extended periods.

For example:

• In a strong uptrend in gold, RSI might stay above 70 for 2-3 weeks.
• Novice traders seeing RSI > 70 immediately sell, often getting stopped out by trend continuation.
• The uptrend is not over, but their long position is closed.

The key point: RSI > 70 does not mean the price will fall. It indicates that buying momentum is still strong.

When the 70/30 Strategy Works Correctly

The 70/30 strategy works best in Sideways (Range-bound) markets.

In this scenario:

• Buy near RSI ~ 30: usually close to support levels (Support).
• Sell near RSI ~ 70: usually close to resistance levels (Resistance).

In trending markets, this strategy can be detrimental.

Professional Techniques for Using RSI Indicator

Here are how professional traders use RSI without relying solely on the 70/30 lines.

1. Divergence - Powerful Warning Signal

Bearish Divergence (Bearish Signal)

• Price makes a new high (Higher High)
• RSI fails to follow, forming a lower high (Lower High)
• Indicates weakening buying pressure even as price reaches a new high
• More reliable when occurring in overbought zones (> 70)

Bullish Divergence (Bullish Signal)

• Price makes a new low (Lower Low)
• RSI does not follow, forming a higher low (Higher Low)
• Indicates waning selling pressure even as price hits new lows
• More reliable when occurring in oversold zones (< 30)

2. Failure Swings - Confirming Trend Reversal

Wilder described Failure Swings as the strongest signals.

Failure Swing Top (Bearish Confirmation)

• RSI crosses downward
• Breaks below previous lows
• Confirms a bearish trend reversal

Failure Swing Bottom (Bullish Confirmation)

• RSI crosses upward
• Breaks above previous highs
• Confirms a bullish trend reversal

3. Centerline Crossover - The 50 Line as a Trend Indicator

The 50 line is more important than you think. It’s the true balance point.

• RSI > 50: Bullish market, consider buying or holding longs
• RSI < 50: Bearish market, consider selling or holding shorts

4. Adjusting RSI Zones According to Trend

This is a game-changer. Understanding that different trends have “different RSI zones” can transform your approach.

In a strong uptrend:

• RSI moves within 40-90, rarely below 30
• The 40-50 zone becomes a new support
• Professionals buy at the 40-50 zone when RSI bounces back, not waiting for 30
• No selling at 70, as it’s against the trend peak

In a strong downtrend:

• RSI moves within 10-60, rarely above 70
• The 50-60 zone becomes a new resistance
• Professionals sell at the 50-60 zone when RSI jumps, not waiting above 70
• No buying at 30, as it’s catching falling knives

Limitations of RSI Indicator

No indicator is perfect. RSI has key weaknesses:

• False signals: Can produce misleading signals, especially in volatile markets
• Lagging indicator: Based on past data (14 bars), so it lags behind price action
• Divergence does not guarantee: Divergence can warn early, but trend can continue

How to Overcome: Use Confluence Strategy

The solution is not to rely solely on RSI.

Technique 1: RSI + Price Action

• Don’t buy just because RSI crosses up
• Buy when RSI crosses up and price touches key support levels
• Don’t sell just because of bearish divergence
• Sell when divergence occurs and price hits key resistance

Technique 2: RSI + MACD

• MACD is good for trend confirmation (Trend Confirmation)
• RSI is good for precise entry timing (Entry Timing)
• Wait for both indicators to align for stronger signals

Case Study: Using RSI in Gold Market

Suppose trading gold (XAUUSD) on a 4-hour timeframe on any platform.

Step 1: Big picture analysis Open daily chart (1D). Notice recent continuous rise, approaching psychological resistance at $4,250.

Step 2: Look for warning signs Price breaks above $4,200, making a new high, but RSI shows clear Bearish Divergence — no new high in RSI, but price does.

Step 3: Wait for confirmation signals

• RSI starts to turn down and breaks previous lows (Failure Swing)
• RSI crosses below 50 (Centerline Crossover)
• Reversal candle appears at resistance

Step 4: Enter trade Once all signals confirm, open a short position on XAUUSD.

Step 5: Manage risk

• Stop Loss: above the high at $4,250
• Take Profit: at previous support around $3,879

Summary

RSI indicator is an excellent momentum tool, but it’s not a “price predictor.” It’s a “strength gauge.”

The most common misconception is oversold at RSI > 70 and overbought at RSI < 30. In trending markets, this strategy fails.

Professional traders combine RSI with Divergence, Failure Swings, Centerline Crossovers, and trend-based zone adjustments for much better results.

By understanding each technique and integrating them with Price Action and other indicators, trading shifts from guesswork to a principled decision-making process.