The Relative Strength Index is a momentum indicator that compares the strength of recent gains to the strength of recent losses, trying to possibly determine the potential for overbought and oversold conditions of a currency pair. It is calculated using the following formula:
RSI = 100 - 100/ (1 + RS*)
(RS is equal to the average of (x) days' up closes / average of x days' down closes.)
The Relative Strength Index, or RSI, ranges from 0 to 100. A currency pair is often thought to be overbought once the RSI approaches the upper area, defined as the 70 level. This means that it may be overvalued and could possibly be ready to have a pullback. Alternatively, if the RSI approaches the lower area, as defined by the 30 mark, it is an indication that the currency pair could be getting oversold and could be undervalued, causing traders to come in and buy it.
The RSI is a simple momentum indicator, and is used by many traders the world over. Because of its simplicity, it is often the centerpiece of a multi-indicator system as it is complementary to so many other indicators out there. Quite often traders will look for such things as exhaustion candles or support breaks when the RSI signals possible overbought conditions as an example.
Much like the MACD, the RSI also is used for spotting divergence as well. Since the RSI measures momentum, you would like to see the RSI gradually increasing in value during fresh new highs. If the new highs are not accompanied by increasing momentum to the upside, it is said to be in divergence. Often, this lack of momentum will lead to a weak undercurrent in an otherwise bullish-looking market. This can often be your first sign that something is amiss.
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