The Relative Strength Index (RSI) is a momentum oscillator that measures the speed and change of price movements. RSI is used to identify overbought or oversold conditions in a market. It oscillates between 0 and 100 and was developed by J. Welles Wilder.
RSI is calculated using the formula: RSI = 100 - (100 / (1 + RS)), where RS is the average of x days' up closes divided by the average of x days' down closes. The default look-back period for RSI is 14 days.
Traders use RSI to identify potential reversal points. An RSI above 70 typically indicates that an asset is overbought, while an RSI below 30 suggests that it is oversold. These thresholds can be adjusted based on market conditions.
RSI can also be used to spot divergence, which occurs when the price of an asset is moving in the opposite direction of the RSI. This can signal a potential reversal.
Traders often use RSI in combination with other indicators and tools to develop trading strategies. Backtesting these strategies on historical data helps to refine and improve their effectiveness.