Imagine a tug-of-war between buyers and sellers in the stock market. Some days, the buyers pull harder, and prices go up. Other days, sellers have the advantage, and prices fall. The Relative Strength Index, or RSI, is a tool that helps measure the strength of these pulls.

Developed by J. Welles Wilder, RSI is a momentum oscillator. It tracks the speed and change of price movements, condensing this information into a single number that ranges from 0 to 100. Its main job is to help traders spot potentially overbought or oversold conditions in a market.

The calculation starts by looking at price changes over a specific period, typically 14 days. We separate the days the price went up (gains) from the days it went down (losses) and find the average for each.

From there, we calculate the Relative Strength (RS), which is the ratio of the average gain to the average loss.

This RS value is then plugged into the main RSI formula to scale it between 0 and 100.

While 14 days is the standard, traders might use shorter periods (like 9 days) for more sensitive, short-term signals or longer periods (like 25 days) for a smoother, long-term view.

The RSI line moves between two extremes. A high RSI suggests that buyers have been dominant, pushing prices up consistently. A low RSI indicates that sellers have been in control.

Traders watch for two key levels:

These levels aren't magic bullets. A strong trend can keep RSI in overbought or oversold territory for a long time. But they are useful reference points for gauging market sentiment and looking for potential turning points.

Now, let's test your understanding of these core concepts.