Suppose Harbor Coffee, our fictional coffee company, reaches an RSI of 75 at $70 a share. Six trading sessions later, the price is $76 and RSI is even higher.
The label “overbought” sounds like a reason to expect a fall. Yet the stock kept climbing while the warning stayed on. This optional indicator describes that climb; it sets no deadline for a reversal.
A score for recent price changes
The relative strength index (RSI) compares the size of recent price gains with recent losses on a scale from 0 to 100. J. Welles Wilder developed it to measure price momentum: the direction and pace of price movement.
RSI is an oscillator, an indicator that moves within fixed bounds or around a centerline. High RSI means gains dominate its calculation; low RSI means losses dominate.
Like moving averages, RSI smooths several observations together. It averages gains and losses separately, giving newer changes more weight as the series continues.
The comparison is within one stock's price history. Comparing a stock with the market is a different task, covered in relative strength. Profits never enter RSI's formula; price versus value asks what the business might be worth.
Where volume counts trading activity, RSI uses only price changes.
Check one simple calculation
Harbor's example begins at its year 3 price of $66. Over the next 14 daily changes, gains total $6 and losses total $2. The price ends at $66 + $6 − $2 = $70.
We use the common 14-period setting and daily closing prices. On a weekly chart, those periods would be weeks. RS means the smoothed average gain divided by the smoothed average loss:
For the first reading, divide each total by all 14 changes. Losses are positive amounts here: a $0.50 fall counts as a $0.50 loss.
| Input | 14-change total | Initial average |
|---|---|---|
| Gains | $6 | $6 ÷ 14 |
| Losses | $2 | $2 ÷ 14 |
The denominators cancel, so RS = 6 ÷ 2 = 3. Then RSI = 100 − 100/4 = 75.
An RSI of 75 means the average gain is three times the average loss.
A falling day adds zero to gains; a rising day adds zero to losses. An unchanged day adds zero to both. For this first reading, each average includes all 14 changes.
Here, six days rose, four fell and four were flat. RSI is 75 even though fewer than half the days rose. The size of the moves matters, not just their count.
Read 70 and 30 as conventions
The conventional labels call RSI above 70 overbought and below 30 oversold. At 50, the smoothed gain and loss averages are equal. These levels are conventions, not universal buy and sell rules.
“Overbought” sounds like “too expensive.” Yet the formula compares gains with losses, without estimating a fair price. Likewise, an oversold reading can reflect a steep decline without making the stock a bargain.
After Harbor's first reading, six consecutive $1 rises take the price from $70 to $76. RSI climbs from 75 to about 87.37. The stock keeps rising while the label stays overbought.
Both panels begin at session 14, when the first RSI reading is available. The climb to session 20 is uninterrupted in both.
A strong trend can keep RSI extreme for a long time. Crossing 70 does not start a countdown to a reversal.
When price and RSI disagree
At session 28, Harbor reaches $77, above the earlier $76 peak. RSI is about 75.16, below its earlier 87.37. A higher price has arrived with a weaker balance of gains to losses.
Divergence means price and an indicator fail to make matching new highs or lows. Harbor shows a developing bearish divergence: a higher price high paired with a lower RSI reading. Traders watch this for signs of weakening upward momentum. It does not tell you the odds or timing of a decline.
As with swing highs, the $76 peak is confirmed by a later decline; $77 is still only a candidate.
If Harbor keeps climbing, both that price and its RSI reading can be surpassed. The last point on a chart is the end of your information, not necessarily the end of the move.
The comparison uses the same daily closes and RSI settings throughout. Switching settings between the two highs would change the measuring stick.
Optional: check the calculation
Fourteen changes need fifteen closes. From $66, the first fourteen dollar changes are:
+1, −0.5, +1, 0, −0.5, +1, 0, −0.5, +1, 0, −0.5, +1, 0, +1.
Add six +1 changes, then −1, +0.5, −1, +0.5, −1, +0.5, +1, +1.5.
After the first reading, Wilder smoothing updates each average as (13 × previous average + new gain or loss) ÷ 14. The next $1 rise gives RSI about 77.97. The averages remember earlier moves. Each new change gets a weight of 1/14; a standard 14-period exponential moving average uses 2/15.
The next optional tool, MACD, measures momentum through the gap between two moving averages.
In short
- RSI compares smoothed price gains with losses; 75 means the gain average is three times the loss average.
- Overbought and oversold describe price momentum, not business value.
- A strong trend can keep RSI above 70 or below 30 for a long time.
- Divergence shows disagreement; the latest price high is still a candidate peak until a later close confirms it.