Relative Strength Index

The Relative Strength Index was developed by J. Welles Wilder, and is an extremely popular momentum oscillator that measures the speed and change of price movements.

The typically used look-back period for RSI is 14, but this can be lower/raised to increase/decrease sensitivity. The RSI oscillates between 0 and 100. Traditionally, and according to Wilder, in his 1978 book, New Concepts in Technical Trading Systems, RSI is considered overbought when above 70 and oversold when below 30. Trading signals can also be generated by looking for divergences and failure swings.
Overbought-Oversold:
Wilder considered RSI readings over 70 as overbought and values below 30 as oversold. But these levels can be adjusted to suit specific market conditions. For instance, 80 can be used as the overbought line in a strong uptrend and 20 as the oversold line during a strong downtrend.

Divergences:

Divergences between price and RSI produce one of the strongest buy and sell signals. A bearish divergence occurs when prices record a higher high, but RSI forms a lower high. The indicator does not confirm the new high and this signifies weakness in the uptrend. Conversely, bullish divergences form when new price bottoms are getting lower, while RSI lows are rising, indicating weakness in the downtrend.

 

Failure Swings:

Failure swings are independent of price action, and are formed solely on the RSI chart. According to Wilder, they provide strong indications of an impending reversal. A bullish failure swing takes place when RSI moves below 30 (oversold), then bounces up above it, pulls back, but holds above the oversold line and then breaks its prior high. A bearish failure swing forms when RSI moves above 70 (overbought), pulls back, forms a lower high below the overbought line, and then breaks its prior low. The following chart provides an example of both bearish and bullish failure swings: