How RSI Indicator works.
RSI - Relative Strength Index
The standard settings for the Relative Strength Index is 14 periods. This means the value of the indicator is based on the last 14 candles. The RSI evaluates how many of those 14 candles were bullish or bearish, analyses the size of of the 14 candles and generally tries to measure the momentum of price.
The RSI value is getting close to 100 (overbought) when the last 14 candles were mostly bullish and the value is getting close to 0 (oversold) when the last 14 candles were mostly bearish. The RSI value is close to 50 (in the middle) when the average gain and loss of the last 14 candles were equal.
Overbought Area (70%)
The RSI value above 70 indicates an overbought situation and suggests a possible price movement to the downside in the future (we do not know exactly when, if it even happens).
Overbought RSI value does not necessarily mean a trend reversal will occur.
Following price movements can occur during an overbought RSI value :
The same counts for the oversold area (30%), just the other way around.
Knowing this, it is easy to understand that the RSI stand alone can’t be a trading signal.
Overbought and Oversold RSI values are simply a sign of price having currently a strong momentum, and therefor might pullback or even reverse soon. However, there is no guarantee of it happening at all.
The RSI should be used as an additional help and the context always needs to be considered. Especially the current trend direction, the time frame and the asset play an important role.
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