Mastering the Correct Way to Use the RSI Indicator: From Beginner to Expert

When it comes to technical analysis, the RSI indicator (Relative Strength Index) is almost an essential tool for every trader. As one of the most widely used indicators in the market, the reason RSI is so popular ultimately lies in its simplicity and ease of understanding—unlike MACD, which requires complex higher mathematics derivation, RSI’s calculation logic can be grasped with basic arithmetic, yet it effectively reflects the relative strength between buyers and sellers in the market.

What exactly does the Relative Strength Index measure?

The English full name of RSI is Relative Strength Indicator, which translates to Relative Strength Index. This name reveals its essence—by comparing the recent strength of upward and downward price movements, it determines whether the market is currently overbought or oversold, thereby guiding entry and exit decisions.

From an application perspective, RSI was originally designed to measure the short-term strength of buyers and sellers, but in practical market use, it has evolved into a multi-functional market analysis tool. It is often displayed alongside KD and MACD indicators below the chart, forming a data support for investor decision-making.

Breakdown of RSI calculation formula

The logic behind RSI calculation is quite straightforward, expressed by the formula:

RSI = (Average of recent gains ÷ ((Average of recent gains + Average of recent losses) ) × 100

The core of this formula is analyzing the magnitude of price increases and decreases over a certain period to quantify the market’s strength comparison. Typically, a short-term RSI uses a 6-day period as a reference.

Let’s look at a specific example. Suppose an asset’s price changes over 6 consecutive days as follows:

• Days 1-2: +1, +3 (upward)
• Day 3: -2 (downward)
• Days 4-5: +2, +4 (upward)
• Day 6: -3 (downward)

Calculation steps:

Step 1: Average gain = (1 + 3 + 2 + 4) ÷ 4 = 2.5

Step 2: Average loss = (2 + 3) ÷ 2 = 2.5

Step 3: Substitute into the formula = 2.5 ÷ (2.5 + 2.5) × 100 = 50

This result shows that when upward and downward movements are balanced, RSI stays around the middle value of 50. If upward momentum is stronger, RSI will break above 50; if weaker, it will fall below 50. In extreme cases, RSI ranges from 0 to 100—100 indicates the entire period was upward only, and 0 indicates only downward movements.

The two major pitfalls of RSI: divergence and dulling

) How to understand divergence

RSI divergence can be categorized into two types: top divergence and bottom divergence.

Top divergence: The price hits a new high within a certain period, but the RSI does not reach a new high, remaining at previous high levels—this usually indicates waning upward momentum, and a rebound may be imminent.

Bottom divergence: The price hits a new low, but RSI does not make a corresponding new low, indicating weakening downward momentum—often a sign of a potential bottom and rebound opportunity.

The essence of divergence is an imbalance in market sentiment. During divergence formation, market participants are under pressure, and when this pressure is squeezed to a certain point, it is suddenly released, leading to a reversal in price.

( Causes and dangers of dulling

A fatal weakness of RSI is the overbought dulling phenomenon. This often occurs during strong upward trends:

According to RSI, the market has entered the overbought zone (RSI > 80), which is generally a signal to take profits. However, in some strong upward trends, prices continue to soar, with increasing magnitude, while RSI’s ascent slows down, eventually forming a gentle upward parabola. This is called dulling—the indicator fails.

The danger of dulling is that if traders overly rely on overbought/oversold signals, they may exit too early in strong trends, missing larger profit opportunities.

Core points for practical RSI application

1. The midline as a dividing line for strength

When RSI crosses above the 50 midline, it indicates bullish strength, and the market is short-term bullish; when RSI drops below 50, it indicates bearish strength, and the market is short-term bearish. This is the most basic judgment method.

2. Two critical thresholds for overbought and oversold

• RSI > 80: Market enters overbought zone, watch out for potential pullback
• RSI < 20: Market enters oversold zone, possible rebound opportunity

3. Conditions for using divergence patterns

Divergence patterns are not always valid. If RSI repeatedly crosses the 50 midline during divergence formation, it indicates the market is oscillating within a range, with no pressure building up, and thus no expected reversal. Therefore, when using divergence, first confirm that RSI remains relatively stable on one side of the midline.

4. Multi-timeframe resonance

Many traders analyze three RSI curves simultaneously—6-day, 12-day, and 24-day:

• If all three are below 50 and form a W-shape, it indicates weakening of the bears and a rebound is imminent
• If all three are above 50 and form an M-shape, it suggests insufficient upward momentum and possible decline

5. Golden cross and death cross

• Golden cross: Short-term RSI crosses above long-term RSI, indicating strong upward momentum, consider entering long positions
• Death cross: Short-term RSI crosses below long-term RSI, indicating waning upward strength, consider closing or shorting

How to avoid RSI dulling?

Since RSI has dulling issues, how can traders avoid this trap?

First, never rely solely on RSI for decision-making. Dulling indicates RSI’s limitations as a short-term indicator. It is essential to incorporate other technical tools like MACD, moving averages, and volume to form a multi-dimensional analysis.

Second, adjust the RSI period. Increasing the period (e.g., from 6 to 12 or 24 days) makes RSI less volatile but reduces sensitivity to market changes. Traders should adjust based on their trading style and timeframe.

Third, combine price action and trend analysis. When RSI dulls, focus on whether prices are still making new highs, whether trendlines are intact, and other fundamental aspects rather than blindly trusting indicator values.

Summary

RSI is indeed one of the most user-friendly tools in technical analysis, but its simplicity can lead traders to over-rely on “numbers.” Understanding the logic behind RSI—namely, the market’s strength comparison—is key to proper use. Although divergence and dulling are “symptoms” of RSI, understanding their causes allows traders to manage risks and seek profits. Remember, RSI is just an auxiliary tool; the ultimate decision-making power always lies with the trader.