Complete Guide to RSI Indicator: Understanding Relative Strength Index, Divergence Phenomena, and Damping Strategies

Investors new to the technical analysis of stocks will inevitably encounter the RSI indicator as a tool. Whether they are seasoned traders or beginners, they regard it as an essential weapon for market analysis. Mastering how to use the RSI indicator can indeed help investors gain deeper insights into market trend changes.

So, what exactly is RSI? How can the RSI indicator be used to determine the appropriate timing for buying and selling? What do common phenomena like “RSI divergence” and “RSI weakening” in the market mean? Don’t let these concepts confuse you. This article will explain the full picture of the RSI indicator in simple language, so let’s explore it together～

Core Concepts of the Relative Strength Index

RSI (Relative Strength Indicator) is an analysis tool used to measure the recent strength of buying and selling forces in the market. It compares the recent upward and downward price movements to assess the ebb and flow of bullish and bearish power. Over time, RSI has become a popular indicator for investors to decide entry and exit points.

The reason RSI is widely favored in the market mainly lies in its straightforward calculation method, unlike indicators like MACD that require complex mathematics. It clearly displays the contest between buyers and sellers, making it an accessible analysis tool for beginners.

On stock technical charts, RSI is usually displayed below the main price chart alongside indicators like KD and MACD, serving as an important reference for deciding whether to enter or exit positions.

In-Depth Analysis of the RSI Formula

The calculation process of the RSI formula is quite intuitive, requiring only basic math operations without complexity. Its essence lies in comparing the price gains and losses over a specific period to gauge market strength. The steps are as follows:

1. Calculate the average gains and losses:

First, set a time period (commonly 14 days).

Within these 14 days, sum all upward movements and divide by 14 to get the average upward movement.

Similarly, sum all downward movements and divide by 14 to get the average downward movement.

2. Calculate the Relative Strength (RS):

Divide the average upward movement by the average downward movement; this result is the Relative Strength (RS).

3. Calculate the final RSI value:

RSI = 100 - (100 ÷ (1 + RS))

Where:

• RS is the Relative Strength, i.e., the ratio of average gains to average losses.
• The resulting value ranges between 0 and 100, representing the RSI indicator.

RSI values always stay within the 0 to 100 range, with two key zones:

Overbought zone (RSI > 70): When RSI exceeds 70, it suggests the market may be overbought, and a price correction could follow.

Oversold zone (RSI < 30): When RSI drops below 30, it indicates the market may be oversold, with potential for a rebound.

These two critical zones are the most widely used standards for applying the RSI formula, helping investors identify potential entry or exit points. However, note that RSI is not an absolute predictive tool; especially during strong upward or downward trends, it may exhibit “weakening” phenomena (discussed later).

Deep Dive into RSI Divergence Phenomena

RSI divergence is a very important signal in technical analysis, referring to a discrepancy between the price trend and the RSI trend. In other words, when the price hits new highs or lows but RSI does not confirm with new highs or lows, it often indicates a potential trend reversal.

RSI divergence is generally categorized into two types: Bearish Divergence (top divergence) and Bullish Divergence (bottom divergence).

( Warning Signal of Top Divergence (Bearish Divergence)

Top divergence occurs when the price reaches a new high, but RSI fails to do so and instead shows a declining trend. At this point, investors should consider reducing their holdings or exiting to avoid potential subsequent declines.

For example, take Bitcoin: when BTC price surged from $70,000 to $100,000, setting a new high, but RSI dropped from 82 to 58. This divergence—price making a new high while RSI does not—indicates weakening upward momentum and suggests a possible correction.

( Rebound Signal of Bottom Divergence (Bullish Divergence)

Bottom divergence appears when the price hits a new low, but RSI does not confirm with a new low and instead shows an upward or flat trend. This usually signals a potential trend reversal. Investors can consider gradually building positions to catch the potential rebound.

When making entry or exit decisions, investors should recognize that divergence phenomena can be viewed as abnormal market sentiment imbalances. During divergence formation, market participants are under pressure; once emotions are pushed to a critical point, a breakout or reversal is likely.

It’s important to note that, although RSI divergence is a powerful analysis tool, it is not an absolute prediction signal. In strong trending markets, divergence may persist longer (detailed later). Patience and confirmation are key.

How to Address RSI Weakening Phenomena

While RSI is advantageous for short-term trend judgment, it has a critical weakness: the overbought/oversold weakening problem.

RSI weakening refers to the RSI remaining in overbought (>70) or oversold (<30) zones for extended periods, losing sensitivity to price changes. This often occurs during strong upward or downward trends, where market sentiment is extremely skewed, causing RSI to become insensitive to ongoing price movements.

For example, during a robust rally, RSI may stay above 70 for a long time. Although this is typically a sell signal, in a strong uptrend, the RSI’s overbought signal may become invalid, and prices continue to rise.

RSI weakening often reflects extreme market psychology. Although it temporarily renders the indicator ineffective, investors can respond with the following approaches:

1. Combine with trend analysis: Even if RSI is overbought or oversold, do not rush into trades; wait for trend reversal confirmation signals.

2. Use other tools: Combine with moving averages, MACD, volume, and other indicators for comprehensive analysis.

3. Adjust RSI parameters: When weakening occurs frequently, consider changing the calculation period (e.g., from 14 days to 10 or 20 days) to increase sensitivity.

4. Risk management: During weakening periods, avoid blindly following the trend; set strict stop-loss levels to control risk.

Practical Application Tips for RSI

) Divergence: Recognizing Trend Reversal Points

RSI divergence is an important indicator for trend reversal, but not all divergences are reliable.

• When the price hits a new high but RSI does not and starts to decline, consider reducing holdings or exiting to avoid further declines.

• When the price hits a new low but RSI does not confirm with a new low and instead shows an upward or flat trend.

However, if during divergence formation, RSI oscillates around the 50 midline, it indicates the market is in a consolidation phase without a clear trend reversal pressure.

) The 50 Midline: Boundary Between Bull and Bear

It’s crucial to understand that divergence patterns are not always applicable. If during divergence formation, RSI repeatedly crosses the 50 midline, it suggests the price is in continuous correction without strong pressure for reversal. Investors should keep this in mind.

• RSI > 50: When RSI exceeds 50, it indicates bullish strength, and the outlook tends to be optimistic.

• RSI < 50: When RSI falls below 50, it indicates bearish strength, and the outlook tends to be pessimistic.

Investors can treat the 50 midline as a dividing line between bullish and bearish forces, further confirmed by trendlines and other indicators.

Identifying Extreme Sentiment Zones

RSI overbought and oversold zones are key references for market sentiment extremes:

• RSI > 80: When RSI rises above 80, it indicates a highly overbought market, with potential for correction.

• RSI < 20: When RSI drops below 20, it indicates a deeply oversold market, with potential for rebound.

In strong trending markets, RSI can become “weak” (鈍化), and overbought or oversold signals may lose validity. Combining with trend analysis and other tools is necessary for accurate judgment.

Multi-Timeframe Combined Application

To avoid limitations of a single-period RSI, investors can set multiple RSI curves with different periods (e.g., 6-day, 12-day, 24-day) to enhance analysis accuracy:

W-shaped and M-shaped Patterns:

• If multiple RSI curves are all below the 50 midline and form a W pattern, it suggests weakening bearish momentum and a possible rebound.

• If multiple RSI curves are all above the 50 midline and form an M pattern, it indicates weakening bullish momentum and a potential downward turn.

Crossing Signals for Trend Judgment

Different period RSIs crossing each other can convey various market signals:

• Golden Cross: When a short-term RSI crosses above a long-term RSI, indicating strong upward momentum and possibly a buy signal.

• Death Cross: When a short-term RSI crosses below a long-term RSI, indicating strong downward momentum and possibly a sell signal.

Flexible Strategies for Adjusting RSI Parameters

Understanding how to set RSI parameters appropriately is key to improving analysis efficiency. The parameters are not fixed; investors should adjust based on their trading style.

RSI Period Settings:

• Short-term RSI (6 days): Sensitive to market fluctuations, suitable for short-term traders capturing small movements.

• Medium-term RSI (12 days): Balances sensitivity and stability, suitable for medium-term positions.

• Long-term RSI (24 days): Less volatile, suitable for macro trend analysis and longer-term investors.

Investors can adjust parameters flexibly:

Extending the Period: Increasing the period (e.g., 14, 30 days) smooths the RSI curve, reducing sensitivity and filtering out short-term noise, suitable for medium to long-term analysis.

Shortening the Period: Decreasing the period (e.g., 3, 5 days) makes RSI more responsive, ideal for short-term trading to catch quick trend changes.

Complementary Use of Other Technical Indicators

RSI should not be used in isolation. Combining it with other key tools enhances analysis:

• MACD: For trend momentum assessment.

• Moving Averages (MA): To confirm trend direction.

• Bollinger Bands: To gauge market volatility.

Using these tools together creates a more comprehensive analysis framework, improving decision accuracy.

New traders can practice on various trading platforms’ demo accounts, repeatedly testing different indicators, and gradually deepen their market understanding, ultimately increasing success in live trading.