RSI: The Technical Indicator That Helps You Anticipate Market Changes

How many times have you seen a stock price go up or down without knowing exactly when to enter or exit? The RSI indicator is a tool that many traders use to solve this problem. But here’s the important part: RSI alone is not enough. It should be combined with trend analysis and other indicators to increase your chances of success.

In this comprehensive analysis, we will explore how RSI works, how to interpret it correctly, and, most importantly, how to use it together with divergence strategies to trade confidently.

Understanding RSI: A Momentum Indicator That Works

The Relative Strength Index (RSI in English) is an oscillator that measures the speed and magnitude of price changes. Unlike trend indicators, RSI is a leading indicator, meaning it can warn of potential changes before they happen.

Why is RSI so effective? Because it performs two key functions:

1. It smooths out extreme price fluctuations, eliminating market “noise”
2. It normalizes results on a fixed scale from 0 to 100, allowing you to compare different assets consistently

The Formula Behind RSI

You don’t need to be a mathematician to trade, but understanding how RSI is calculated will give you confidence in what it shows:

RSI = 100 - [100 / (1 + RS)]

Where RS (Relative Strength) = Average of Bullish Closes / Average of Bearish Closes

By default, RSI uses 14 periods, but you can adjust it according to your trading style (shorter periods for active trading, longer periods for medium-term positions).

What Do RSI Levels Mean?

This is where RSI becomes really practical. Traders should pay attention to three main zones:

( Overbought Zone )RSI > 70###

When RSI exceeds 70, the market is “hot.” Buyers dominate, but this creates an unsustainable scenario. The question every trader should ask is: How long can this buying pressure last?

The reality is that assets can remain overbought for extended periods if investors maintain appetite for buying at higher prices. However, when RSI finally drops from this zone:

• It could be just a temporary correction in a stronger uptrend
• Or it could signal the start of a bearish reversal

( Oversold Zone )RSI < 30###

The opposite occurs when RSI falls below 30. Selling panic temporarily dominates, but again, an asset can stay oversold if its fundamentals are weak.

When RSI leaves the oversold zone:

• Prices may bounce in an upward correction within a broader downtrend
• Or a trend reversal to the upside could be confirmed

( The Middle Zone )RSI = 50###

This often-overlooked level is critical for validating trends. Think of it as the “gas tank” of the movement:

• If RSI oscillates between 50 and 70 while price rises, there is fuel to continue bullish
• If it oscillates between 50 and 30 while price falls, there is fuel to continue bearish
• If the indicator crosses to the other side of the middle zone, the trend is losing strength

Real Cases: How RSI Works in Practice

( Example 1: Tesla - Identifying Corrections vs. Reversals

Look at Tesla’s weekly chart )NASDAQ: TSLA### between 2019 and 2022:

In May 2019, RSI enters oversold. Later, when it exits that extreme zone, a clear uptrend begins to develop. But here’s the key point: between June and December 2020, RSI makes three consecutive highs in the overbought zone. Instead of falling sharply, it only retraces to the middle zone before recovering.

What does this tell us? Corrections are mild, confirming that the uptrend remains dominant. This was the ideal moment to increase long positions, not to sell.

However, in October 2021, something changed. RSI no longer reached new highs in the overbought zone, while the price started forming lower highs. This was the warning sign: the trend was losing momentum.

In December 2021, the previous uptrend was broken and RSI dropped to oversold. As long as the indicator oscillates between the low extreme zone and the middle zone, prices will continue to decline.

( Example 2: Meta Platforms - The Middle Level is Your Ally

On Meta Platforms’ weekly chart )NASDAQ: META### from 2020:

After a low in the oversold zone in March 2020, the price started a strong uptrend. Here’s the pattern: as long as RSI stays oscillating between the middle zone (50) and the overbought zone (70), the price keeps rising. Each RSI pullback that doesn’t go below 50 simply pauses the uptrend.

But in February 2022, the chart changes. RSI finally drops below 50 and approaches the oversold zone. Price breaks its previous uptrend line. As long as RSI remains between the oversold zone and level 50, the dominant downtrend will continue.

Trading Signals with RSI: When to Act?

( Buy Signal: The Three-Point Pattern

To execute a solid long entry, these three conditions must be met:

1. RSI enters oversold )below 30### - This is the necessary condition
2. RSI returns to the fluctuation band - The indicator begins to recover
3. Price breaks the previous downtrend line - This is the sufficient condition validating the trade

Example: Taiwan Semiconductor (NYSE: TSM) between September and October 2022 showed this perfect setup. When RSI exited oversold and price broke the downtrend line, it was the moment to go long.

( Sell Signal: The Opposite Pattern

To execute a solid short entry:

1. RSI enters overbought )above 70### - Necessary condition
2. RSI returns to the fluctuation band - The indicator begins to fall
3. Price breaks the previous uptrend line - Sufficient condition to open shorts

Example: Applied Materials (NASDAQ: AMAT) showed a clear short entry in January 2022 when these three conditions were met after months in overbought.

Critical point: RSI often makes multiple inflection points within extreme zones before returning to the fluctuation band. Don’t jump prematurely; wait for the previous trend to break.

The Secret Weapon: Divergence Trading with RSI

This is where many beginner traders lose money: they rely on extreme RSI levels without considering what’s really happening in prices.

Divergence occurs when RSI moves in the opposite direction to price. When you identify divergence, you’re observing a significant disconnect that typically precedes a trend reversal.

( Bullish Divergence: The Bounce Signal

It forms when:

• Price makes lower lows )bearish trend###
• But RSI makes higher lows (loss of bearish momentum)

Interpretation: Selling pressure is waning. An upward move is likely in subsequent periods.

Example: Broadcom (NASDAQ: AVGO) clearly showed this setup. While prices fell to new lows, RSI stayed at higher levels than previous lows. This disconnect correctly predicted a bullish reversal that lasted months.

( Bearish Divergence: The Correction Signal

It forms when:

• Price makes higher highs )bullish trend###
• But RSI makes lower highs (loss of bullish momentum)

Interpretation: The market is losing strength despite higher prices. A downward correction is likely.

Example: Walt Disney (NYSE: DIS) presented this classic divergence. Prices kept rising, but RSI failed to reach new highs. This warning foreshadowed a bearish reversal that lasted over a year.

Divergence trading is probably the most powerful signal generated by RSI. Professional traders actively seek it because it has a high accuracy rate.

Boost RSI: Combining It with MACD

RSI has limitations, especially on very short timeframes. For more robust signals, many traders combine it with MACD (Moving Average Convergence Divergence).

The combined system works as follows:

Condition 1: RSI in extreme zone (overbought or oversold) Condition 2: RSI returns to the fluctuation band Condition 3: MACD makes a cross of the histogram’s midline in the opposite direction of the previous trend ← This is the entry signal Condition 4: MACD crosses the SIGNAL line in the opposite direction ← This is the exit signal

( Practical Case: Block Inc. )NYSE: SQ###

The chart showed initial overbought. RSI started to decline and returned to the fluctuation band. When MACD crossed below its histogram midline, bearish weakness was confirmed. That was when the short position was opened.

The trade lasted 4 months until MACD crossed above the SIGNAL line, generating the exit signal. This combined system eliminated false positives that RSI alone would have generated.

Conclusion: RSI, Your Precision Tool

RSI is not a perfect predictor, but when combined with trend analysis, divergences, and other oscillators like MACD, it becomes a very effective tool.

The three pillars for trading with RSI are:

1. Recognize extreme zones (s overbought and oversold)
2. Validate with trend breakouts (don’t trade only at extremes)
3. Look for divergences (the most powerful signal of the indicator)

Remember: RSI is a necessary condition, but breaking a previous trend is the sufficient condition to open a trade with confidence. Combine both, and you’ll be trading like the professionals.