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The RSI Indicator: How It Is Calculated and Why "Overbought" Is Not a Forecast

The Relative Strength Index compares recent gains with recent losses on a 0–100 scale. How Wilder's RSI is calculated and why overbought is not a sell signal.

By Published 4 min read

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Key takeaways

  • The RSI, developed by J. Welles Wilder and published in 1978, measures the size of recent gains against recent losses on a scale from 0 to 100.
  • RS is the average gain divided by the average loss over a look-back period, 14 by default, and RSI = 100 − 100 ÷ (1 + RS).
  • Readings above 70 are conventionally called overbought and below 30 oversold.
  • In a strong trend the RSI can stay overbought or oversold for a long time, so those labels describe momentum, not a coming reversal.
  • Like every indicator, RSI summarises past prices and cannot confirm what happens next.

The Relative Strength Index, or RSI, is what ChartSchool calls a popular momentum indicator. It condenses recent price movement into a single number between 0 and 100, and readings above 70 and below 30 are labelled "overbought" and "oversold". Those labels sound like predictions. They are not, and the indicator's own reference material shows why.

Where it comes from

StockCharts' ChartSchool describes the RSI as a momentum oscillator developed by J. Welles Wilder, which measures the speed and change of price movements and oscillates between zero and 100. Wilder presented it in his 1978 book New Concepts in Technical Trading Systems, alongside other indicators such as the Average True Range.

"Relative strength" here means the strength of a stock's recent gains relative to its recent losses, not its strength relative to the market, which is a different measure with a similar name.

The calculation

ChartSchool sets out three components: average gain, average loss and RS.

  1. Choose a look-back period. Wilder's default is 14 periods.
  2. For each period, record the gain (if the close rose) or the loss (if it fell). Losses are expressed as positive numbers.
  3. First values: average gain = sum of gains ÷ 14; average loss = sum of losses ÷ 14.
  4. Later values are smoothed: new average = (previous average × 13 + current gain or loss) ÷ 14.
  5. RS = average gain ÷ average loss.
  6. RSI = 100 − 100 ÷ (1 + RS).

A quick check of the formula. If the average gain is 1.2 and the average loss is 0.6, RS = 2 and RSI = 100 − 100 ÷ 3 ≈ 66.7. If gains and losses are equal, RS = 1 and RSI = 50. ChartSchool notes the extremes: RSI is 0 when there were no gains in the period, and 100 when there were no losses.

Because of the smoothing, RSI values depend on how much history is used; ChartSchool says it uses at least 250 data points before a chart's start, so different software can show slightly different values.

Overbought and oversold

Wilder considered RSI overbought above 70 and oversold below 30. ChartSchool adds that the thresholds can be adjusted, for example to 80 and 20, and that a shorter look-back makes extreme readings more frequent: a 10-day RSI reaches the extremes more often than a 20-day one, and a volatile stock more often than a steady one. Volatility explained covers why some stocks swing more than others.

Why "overbought" is not a forecast

ChartSchool's own worked example makes the point. A stock became overbought in mid-September, did not decline, stalled for a couple of weeks and then continued higher, producing three more overbought readings before it finally peaked. The general lesson it draws: momentum oscillators can become overbought, or oversold, and remain so in a strong trend. Overbought and oversold readings, it notes, tend to work best when prices are moving sideways within a range, which you only know for certain afterwards.

So an RSI of 75 says one thing: over the look-back period, gains have been much larger than losses. It does not say they are about to stop.

Settings change the picture

Because the RSI depends on its look-back period, two charts of the same stock can disagree. ChartSchool notes that short-term traders sometimes use a 2-period RSI with 80 and 20 as thresholds, while the default 14-period version with 70 and 30 is less sensitive, since ChartSchool notes a longer look-back decreases sensitivity. Neither setting is correct in general; each is a different summary of the same prices. If you compare RSI readings across stocks or across sources, check that the period and thresholds match, and remember that a reading which crosses a line because you changed the setting tells you nothing new about the stock.

Divergences

ChartSchool describes Wilder's view that divergences signal potential reversals, because momentum is not confirming price:

  • Bearish divergence: price makes a higher high while RSI makes a lower high.
  • Bullish divergence: price makes a lower low while RSI makes a higher low.

These are interpretations of past data, not guarantees; a divergence can persist through further moves in the same direction.

Putting RSI in its place

RSI is one summary of price momentum. It ignores everything about the underlying business, which is the domain of fundamental analysis; technical versus fundamental analysis compares the two approaches. It also works from the same past prices as other indicators, so combining it with moving averages or MACD adds less independent information than it might seem.

The listing for our simulator, Learn to Trade Stocks Beginner, describes the right attitude: technical indicators summarise price or volume information but cannot confirm a future outcome or remove uncertainty. Its lessons include momentum indicators, and its chart replay lets you test your reading of them on simulated price action with a virtual balance. It is one of our education apps; the investing basics hub has the other chart guides.

Good to know

Frequently asked questions

What is the RSI indicator?
A momentum oscillator, developed by J. Welles Wilder, that compares the average size of recent price gains with the average size of recent losses and expresses the result on a scale of 0 to 100. Higher values mean recent gains have outweighed losses.
How is RSI calculated?
Over the look-back period, usually 14, compute the average gain and the average loss, with losses expressed as positive numbers. Divide them to get RS, then RSI = 100 − 100 ÷ (1 + RS). Later values smooth the averages: the prior average times 13, plus the latest value, divided by 14.
Does an RSI above 70 mean the stock will fall?
No. ChartSchool notes momentum oscillators can become overbought and remain so in a strong uptrend, and gives examples of stocks that kept rising after overbought readings. The reading says recent gains have been large, not that they are about to reverse.
What is an RSI divergence?
When price and RSI move in different directions, for example the price making a higher high while RSI makes a lower high. Wilder viewed divergences as signs of potential reversal, but they too can persist or fail.

Sources

  1. Relative Strength Index (RSI) (ChartSchool) (opens in a new tab)StockCharts.com — accessed
  2. Learn to Trade Stocks Beginner (store listing) (opens in a new tab)Google Play — accessed

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