Definition
The Relative Strength Index (RSI) is a technical indicator that compares the force of recent price rises with the force of recent price falls over a set period, and shows the result as a number from 0 to 100. American technical analyst Welles Wilder came up with it in 1978. It helps you judge whether a stock has climbed too steeply in a short time (overbought), or dropped too steeply and sunk into a slump (oversold).
A speedometer for how steeply a price has run
An athlete who sprints for a long time soon has to gasp for air and slow down. Stock prices work the same way. When a price shoots up without a break, the buyers run out of steam and more people want to sell. On the other hand, when a price tumbles off a cliff, some people step in and say, "This is cheap enough now."
The Relative Strength Index measures exactly this: how strong the tug-of-war between buying and selling is, as a number. It usually looks at the last 14 days of price moves. It adds up all the gains over 14 days and divides by 14 to get the "average gain." It does the same for the losses to get the "average loss." Then it compares the two as a ratio.
If the price rose every single day, the index gets close to 100. If it only fell every day, it gets close to 0. With a number between 0 and 100, you can check objectively how hot the market's engine is running right now.
What 70 and 30 tell you about overheating and slumps
When investors read the RSI, two baseline levels matter most: the 70 line and the 30 line. When the index goes above 70, it is called the "overbought" zone. It means too many people rushed in to buy at once, so the price climbed steeply in a short time. It is not a verdict that the stock is expensive compared with the company's value. It is a number that shows the speed and size of the rise.
On the other hand, when the index falls below 30, it is classed as the "oversold" zone. It signals that too many frightened people dumped their shares, so the price fell steeply in a short time.
So many investors treat a drop after the index punches through 70 as a hint: "Time for a breather, maybe I should sell?" And when the index dips below 30 and then turns back up, some see a chance: "It has firmed up at the bottom, maybe I should buy?"
To be more precise: above 70 does not mean an instant drop
To be more precise, an RSI above 70 does not mean the price will crash tomorrow. A super-strong stock that has big good news and the whole market's attention can keep surging for days, or even weeks, with the index stuck above 70 or 80.
People often say the indicator is "glued to the ceiling." If you rush to sell because "it's over 70, so I must sell," you risk missing a huge rally.
On the other hand, a stock hit by major bad news can sit below 30 and keep falling, as if there were a basement beneath the bottom. So instead of blindly trusting the RSI alone, it is a safer investing habit to look at it together with the company's earnings, trading volume, and other supporting indicators.
Common misconceptions
When the RSI goes above 70, the price always drops right away.
In a strong uptrend, a price can keep rising for a long time with the RSI far above 70. A reading of 70 does not confirm a drop. It is just a reference signal that the stock is "overheated."
Where you meet it
A game company's new title becomes a huge hit, its stock hits the daily upper limit day after day, and its RSI shoots up to 85.
When the whole market crashes, even a solid company's stock gets swept down with it, and its RSI falls to 20 or below.
In one sentence
The Relative Strength Index shows the force of recent rises and falls on a 0-to-100 scale, and tells you whether the market is overheated or in a slump.