It is a technical momentum indicator that compares the magnitude of recent gains to recent losses in an attempt to determine the overbought and oversold conditions of a currency/share. It is calculated using the following formula:
RS = Average of X days' up closes / Average of X days' down closes
Refering to the chart below, we can see that the RSI ranges from 0 to 100. The currency/share is deemed to be overbought once the RSI approaches the 80 level, meaning that it may be getting overvalued and there is a good chance that the price might fall. It works the reverse if the RSI approaches 20, it is an indication that the currency/share may be getting oversold and undervalued and there exist a possibility that the price might increase.
RSI is a famous tool because it can be used to indicate trend formations. When you find a trend forming, you can take a look at the RSI. If the RSI is up above 50, a up trend is in the making, else a down trend is in the making. If you are looking at a possible uptrend, you should be sure to make the RSI is above 50, and when you are looking at a possible downtrend, you have to make sure the RSI is under 50.
So in summary, RSI
1. Simply measures the overbought/oversold readings
2. Identify potential reversal points
3. Occassional Divergence Strength
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