Complete Guide to RSI Indicator: Mastering Divergence and Diminishing Signals of the Relative Strength Index

If you are just starting to learn technical analysis, the term “RSI indicator” should be familiar. RSI is one of the most popular technical analysis tools in the market and is also a required course for many new traders. Learning to interpret RSI can definitely help you gain a deeper understanding of market dynamics!

So, what exactly is RSI? How do you use it to judge buy and sell opportunities? And how should you respond to common phenomena like “RSI divergence” and “RSI weakening”? Don’t worry, this article will guide you step-by-step to master the core applications of the RSI indicator in an easy-to-understand way.

Principles of the Relative Strength Index

RSI (Relative Strength Indicator) is an important tool for measuring the comparison of buying and selling forces in the recent market. It compares the magnitude of recent gains and losses of a stock or crypto asset to assess changes in market bullishness and bearishness. Over time, RSI has become a commonly used indicator for investors to determine entry and exit points.

RSI is popular mainly because its calculation method is simple and easy to understand, requiring no complex mathematical knowledge. It effectively reflects the balance of buying and selling forces in the market and is an accessible indicator for beginners. On technical analysis charts, RSI is usually displayed below the main chart alongside indicators like KD and MACD, serving as an important reference for decision-making.

Detailed Explanation of RSI Calculation Formula

The calculation of RSI is very straightforward, involving basic addition, subtraction, multiplication, and division. Its core is to compare the magnitude of price increases and decreases over a period to measure market strength. The specific steps are as follows:

Step 1: Calculate the average gain and average loss

Choose a time period (usually 14 days). During these 14 days, sum all upward price movements and divide by 14 to get the “average gain.” Similarly, sum all downward movements and divide by 14 to get the “average loss.”

Step 2: Calculate Relative Strength (RS)

Divide the “average gain” by the “average loss” to obtain the “Relative Strength” (RS).

Step 3: Calculate RSI value

$$RSI = 100 - \frac{100}{1 + RS}$$

where RS is the “Relative Strength,” i.e., the ratio of average gain to average loss. This yields a value between 0 and 100.

The RSI value always ranges between 0 and 100, with two key zones:

• Overbought zone (RSI > 70): indicates the market may be overbought, with a risk of price correction
• Oversold zone (RSI < 30): indicates the market may be oversold, with a potential rebound opportunity

Note that RSI is not an absolute predictive tool. Especially during strong upward or downward trends, phenomena like “weakening” can occur.

Deep Understanding of RSI Divergence

RSI divergence is a very important signal in technical analysis, referring to a mismatch between price movement and RSI trend. Simply put, it occurs when the price makes a new high or low, but RSI does not follow suit. This often hints that the current trend may be about to reverse.

RSI divergence is generally categorized into two types:

Top Divergence (Bearish Divergence)

When the price hits a new high but RSI fails to reach a new high and instead declines, this divergence suggests weakening upward momentum. Investors should consider reducing positions or exiting to avoid potential subsequent declines.

For example, in Bitcoin, when BTC price rises from $70,000 to a new high of $100,000, but RSI drops from 82 to 58, this forms a top divergence. It indicates that the bullish momentum is waning, and a correction may be imminent.

Bottom Divergence (Bullish Divergence)

When the price hits a new low but RSI does not make a new low and instead rises or stays flat, this usually signals a potential trend reversal upward. Traders might consider entering gradually to catch a potential rebound.

Understanding divergence involves recognizing it as a sign of abnormal market sentiment imbalance. During divergence formation, market participants are under pressure, and when this pressure reaches a breaking point, it can trigger a price reversal.

However, note that while RSI divergence is a powerful tool, it is not an absolute prediction. It should be used in conjunction with other indicators and market context. During strong trends, divergence signals can persist for a long time, requiring patience for confirmation.

RSI Weakening Phenomenon and Response Strategies

RSI weakening refers to the RSI staying in overbought (>70) or oversold (<30) zones for an extended period, losing sensitivity to price changes. This often occurs during strong upward or downward trends, where market sentiment is heavily biased, causing RSI to fail to reflect actual price movements promptly.

For example, during a vigorous rally, RSI may remain in the overbought zone (>70) for a long time. Although this can be a sell signal, in a strong uptrend, the overbought condition might be invalid, and prices can continue rising.

While RSI weakening can temporarily impair the indicator’s effectiveness, traders can adopt the following approaches:

1. Combine with trend analysis: Even if RSI is overbought or oversold, avoid rushing to buy or sell immediately; wait for trend reversal confirmation.

2. Use other indicators for confirmation: Combine moving averages, MACD, volume, and other tools to assess market trends comprehensively.

3. Adjust RSI parameters: If weakening occurs frequently, consider changing the RSI period (e.g., from 14 days to 10 or 20 days) to improve sensitivity.

4. Risk management: During weakening periods, avoid impulsive chasing or panic selling; set strict stop-losses to control risk.

Practical RSI Application Guide

RSI and the 50-Midline: The Battle Between Bulls and Bears

The 50 midline is an important reference point for RSI, representing a balance of buying and selling forces:

• RSI > 50: indicates bullish dominance, suggesting a potentially optimistic outlook
• RSI < 50: indicates bearish dominance, suggesting a potentially pessimistic outlook

However, if the RSI repeatedly fluctuates around 50 during divergence formation, it indicates a sideways correction phase without a clear trend reversal. In such cases, divergence signals are less reliable.

Extreme Signals in Overbought and Oversold Zones

RSI’s overbought and oversold zones reflect extreme market sentiment:

• RSI > 80: indicates an overbought condition, with a risk of price correction
• RSI < 20: indicates an oversold condition, with a potential rebound

In strong trends, RSI may become “sluggish,” and overbought or oversold signals might lose validity. Always combine with trend analysis and other indicators.

Multi-Period RSI Analysis

To mitigate the limitations of a single-period RSI, traders often set multiple RSI curves with different periods (e.g., 6, 12, 24 days) to improve analysis accuracy:

W and M Pattern Recognition:

• If multiple RSI curves are below 50 and form a W pattern, it suggests weakening bearish momentum and a possible rebound.
• If multiple RSI curves are above 50 and form an M pattern, it indicates weakening bullish momentum and a possible reversal downward.

Golden Cross and Death Cross

Crossovers between different RSI periods can signal market shifts:

• Golden Cross: when a short-term RSI crosses above a long-term RSI, indicating strong upward momentum and a potential buy signal.
• Death Cross: when a short-term RSI crosses below a long-term RSI, indicating strong downward momentum and a potential sell signal.

Best Practices for RSI Parameter Settings

RSI parameters are adjustable based on your trading style. Common settings include:

• RSI (6 days): short-term, highly sensitive, suitable for quick trades
• RSI (12 days): medium-term balance between sensitivity and stability
• RSI (14 days): standard, most widely used
• RSI (24 days): long-term, smoother, suitable for medium to long-term analysis

Increasing the period (e.g., 30 days): makes the RSI line smoother and less sensitive to short-term fluctuations, ideal for long-term investors to filter out noise.

Decreasing the period (e.g., 3 or 5 days): makes RSI more responsive, suitable for short-term traders aiming to catch quick moves.

Summary

As a classic technical analysis tool, RSI provides valuable insights into market buy and sell timing. Mastering the understanding of RSI divergence, recognizing weakening signals, and applying multi-period analysis can significantly enhance your trading accuracy.

Remember, no single indicator guarantees 100% accuracy. The smartest approach is to combine RSI with other technical tools (like MACD, moving averages, Bollinger Bands) and fundamental analysis, along with sound risk management principles, to stay ahead in trading.

Through repeated practice and real-market application, you’ll develop a keen market sense, and the RSI indicator will become a powerful assistant in your trading toolbox.