What it measures
RSI compares the size of recent up-closes with recent down-closes over N periods (14 by default) and scales the result from 0 to 100. High readings mean recent gains have dominated; low readings mean losses have.
The 70/30 trap
The textbook says above 70 is overbought and below 30 is oversold. In a range that is useful: price at the top of the range with RSI at 75 is a fair place to look for a short.
In a trend it is a way to lose money. A strong uptrend pins RSI above 70 for days while price keeps climbing. "Overbought" there means "strong", not "about to fall".
Divergence
The RSI signal that holds up best is divergence: price makes a new high, but RSI makes a lower high. Momentum is fading even as price pushes on. It does not time the turn — divergence can persist through several more highs — but it is a warning to tighten stops and stop adding.
- Bearish divergence: higher high in price, lower high in RSI.
- Bullish divergence: lower low in price, higher low in RSI.
Using it
- 1.Establish the trend from structure, not from RSI.
- 2.In a range, use extremes at range edges as a filter for reversal setups at your levels.
- 3.In a trend, ignore extremes; watch for divergence at the swings.
Summary
RSI measures recent momentum. Extremes mean reversal in ranges and strength in trends; divergence is the signal worth respecting in both.