The Relative Strength Index (RSI) is a popular momentum oscillator that was developed by J. Welles Wilder. The RSI compares the magnitude of a stock or index’s recent gains to the magnitude of its recent losses and converts this information into a number that ranges from 0 to 100. Below is an example of the DOW index with its 20, 50, 100 and 200 day simple moving averages (SMA), and the RSI oscillator.
There are a few ways to interpret and use the RSI:
Oversold/Overbought: If the RSI falls below 30 the stock/index is oversold, and if the RSI rises above 70 it is overbought. Additionally, if the stock/index trends above 30 it is considered bullish, and if the RSI trends below 70, it is a bearish signal. Some traders identify the long-term trend of a stock/index and then use extreme readings of the RSI as entry points. For example, if the long-term trend of a stock/index has been bullish, then a temporary RSI reading near 30 could mark a potential entry point.
Center-line crossover: The center-line for RSI is 50. A reading above 50 indicates that average gains for the stock/index are higher than average losses, and a reading below 50 indicates that losses are winning the battle. Some traders look for a move above 50 to confirm bullish signals or a move below 50 to confirm bearish signals.
As we can see for the DOW index chart above, the RSI dipped below 50. As a result, the RSI is telling us that average losses have been higher than the average gains over the last few weeks and sentiment is currently slightly bearish.