What is relative strength index (RSI) CALCULATION, RSI VALUES & DIVERGENCE

The Relative Strength Index (RSI) is a momentum oscillator that measures the speed and change of price movements in a financial asset, indicating whether it is overbought or oversold. Developed by J. Welles Wilder, the RSI is one of the most widely used technical indicators in technical analysis.

Here's how the Relative Strength Index works:

1. Calculation : The RSI is calculated using the following formula:

   

   RSI = 100 - [100 / (1 + RS)]

   where RS (Relative Strength) is the ratio of average gains to average losses over a specified period. The most common period used for RSI calculation is 14 periods, which can be days, weeks, or any other time frame.

2. Interpretation of RSI Values :

   - RSI values range from 0 to 100.

   - A reading above 70 is considered overbought, suggesting that the asset may be due for a price correction or reversal to the downside.

   - A reading below 30 is considered oversold, indicating that the asset may be undervalued and due for a price bounce or reversal to the upside.

   - RSI values between 30 and 70 are often considered neutral or ranging, indicating that the asset's price is neither significantly overbought nor oversold.

3. Divergence : RSI divergence occurs when the price of an asset forms higher highs or lower lows, while the RSI indicator does not confirm these price movements. Bullish divergence occurs when the price forms lower lows, but the RSI forms higher lows, indicating potential upward momentum. Conversely, bearish divergence occurs when the price forms higher highs, but the RSI forms lower highs, signaling potential downward momentum. Divergence is commonly observed with oscillators such as the Relative Strength Index (RSI), Moving Average Convergence Divergence (MACD), and Stochastic Oscillator. Traders use divergence signals to anticipate potential trend reversals, confirm existing trends, or identify entry and exit points for trades.

It's important to note that while divergence can provide valuable insights into market dynamics, it should not be used in isolation. Traders often combine divergence signals with other technical indicators, chart patterns, and fundamental analysis to make well-informed trading decisions. Additionally, false signals can occur, so traders should exercise caution and consider risk management strategies when trading based on divergence signals.

4. Confirmation Signals : Traders often use RSI signals in conjunction with other technical indicators or chart patterns to confirm trading signals. For example, a bullish RSI divergence combined with a bullish candlestick pattern may strengthen the bullish case for a trade.

5. Overbought and Oversold Conditions : While RSI readings above 70 and below 30 indicate potential overbought and oversold conditions, respectively, it's important to note that markets can remain overbought or oversold for extended periods, especially in strong trending markets. Therefore, traders use RSI readings in conjunction with other indicators and analysis techniques to avoid false signals and confirm trend reversals.

The Relative Strength Index is a versatile tool used by traders and investors to identify potential trend reversals, gauge the strength of price momentum, and make more informed trading decisions. However, like any technical indicator, it is not foolproof and should be used in conjunction with other analysis methods and risk management techniques.