RSI Formula and the Truths Professional Traders Use to Read the Market

RSI (Relative Strength Index) is a well-known indicator that has dominated trading markets for a long time. However, misconceptions about how to use it can cause traders to lose more money than they think. Today, we’ll delve into what the true RSI formula really means and how skilled traders use it to read market sentiment—not to guess turning points randomly.

RSI Is Not a Tool to Predict Tops and Bottoms

Most beginners learn that RSI should be “bought at 30 and sold at 70,” but this is a serious misunderstanding. When RSI moves above 70, it’s considered Overbought (too expensive), and below 30, it’s Oversold (too cheap). But interpreting it this way leads you to “counter-trend” trading, which is one of the fastest ways to blow your account.

The most important thing: RSI is a momentum indicator, not a reversal predictor. If RSI stays high and remains above 70 for a long time, it doesn’t mean the market will turn down. It indicates that the buying momentum is very strong. In a strong uptrend, RSI can stay in overbought territory for weeks.

The RSI Formula: The Origin of Everything

Most traders don’t need to calculate RSI manually because trading platforms do it automatically. But understanding how the RSI formula works can help you use it more effectively.

At its core, it’s based on the ratio of RS (Relative Strength):

RS = Average Gain / Average Loss

Once you have RS, the RSI formula is:

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

The result is a number between 0 and 100.

What does this formula mean?

• If Average Gain > Average Loss (RS > 1), RSI will be above 50.
• If Average Gain < Average Loss (RS < 1), RSI will be below 50.
• If Average Gain equals Average Loss (RS = 1), RSI equals 50.

This is crucial because the 50 line is the true equilibrium point of the market, not 70 or 30.

The Second Common Mistake: The 70/30 Strategy

Traditional trading systems say “buy at 30 and sell at 70,” but this can quickly blow your portfolio.

Why? Because this strategy only works well in sideways (range-bound) markets. In strong trends, RSI can stay outside the 30-70 range for extended periods:

• In a strong uptrend: RSI may stay above 70 for weeks. Selling every time RSI hits 70 means you miss out on further gains.
• In a strong downtrend: RSI may stay below 30 for a long time. Buying just because RSI is low is like “catching a falling knife.”

The 50 Level: The Professional’s Boundary

Instead of focusing solely on 70 and 30, professionals look at the 50 line first:

• RSI > 50: Bullish market, buying pressure dominates.
• RSI < 50: Bearish market, selling pressure dominates.

As long as RSI stays above 50, you can hold long positions safely. When RSI crosses below 50, it’s a warning that the trend may be reversing.

Advanced Techniques: Divergence and Failure Swings

These are two techniques that separate amateurs from professionals.

Bullish Divergence: When price makes a new low (Lower Low), but RSI makes a higher low, indicating weakening selling pressure and a potential trend reversal upward. Especially reliable if RSI is below 30.

Bearish Divergence: When price makes a new high (Higher High), but RSI makes a lower high, signaling weakening buying momentum. Particularly significant if RSI is above 70.

Failure Swings: A powerful signal described by RSI creator J. Welles Wilder Jr. — when RSI shows divergence, then breaks its previous high or low, confirming a trend change. Traders often enter after this confirmation.

How RSI Adjusts to Different Trends

This is a key insight that differs from traditional teachings:

In a strong uptrend:

• RSI tends to stay in high ranges, roughly 40–90 (rarely drops to 30).
• The 40–50 zone acts as a new support.
• Professionals buy when RSI dips into 40–50 and bounces, not waiting for 30.

In a strong downtrend:

• RSI stays in low ranges, about 10–60 (rarely rises to 70).
• The 50–60 zone acts as resistance.
• Professionals sell when RSI rises into 50–60 and fails to go higher, not waiting for 70.

In sideways markets:

• The classic 30–70 strategy works best.
• Buy near 30 support, sell near 70 resistance.

Using Centerline Crossovers with Different Tools

For trend-following traders focusing on long-term trends, waiting for RSI to cross the 50 line can be more effective than 70/30 signals:

• RSI crossing above 50: Trend turning bullish, consider buying.
• RSI crossing below 50: Trend turning bearish, consider selling.

Smart traders don’t rely on RSI alone. They use confluence — multiple signals confirming the same move — such as:

• RSI + Price Action: Buy when RSI hits 30 AND price hits a key support.
• RSI + MACD: Buy when RSI shows bullish divergence AND MACD crosses up.
• RSI + Support/Resistance: Sell when price breaks resistance AND RSI shows bearish divergence.

Real Example: Trading Gold with the Correct RSI Approach

Imagine trading XAUUSD (gold) on a 4-hour chart:

Step 1: Price rises from 3,850 to 4,200, RSI stays high and remains above 70.

Step 2: Price makes a new high at 4,200, but RSI fails to make a higher high — a Bearish Divergence warning.

Step 3: Instead of rushing to sell, wait for confirmation — RSI drops below 50 and breaks down (Failure Swing).

Step 4: At 4,150, bearish engulfing candles appear, and RSI drops below 50 — a strong confirmation to sell.

Step 5: Place Stop Loss above recent high (say 4,200), and target support at 3,850.

This approach provides clear entry points, reasonable stops, and good risk-reward ratios — the hallmark of professional trading.

Limitations and How to Overcome Them

RSI weaknesses:

• Can give false signals in choppy, volatile markets.
• Divergence signals can take a long time to develop, and price may continue in the trend.
• RSI is a lagging indicator; it follows price, not leads it.

How to fix this: Never rely on RSI alone. Use confluence — multiple signals from different tools — to increase confidence.

Learn Correctly, Profit Consistently

Most mistakes by new traders aren’t due to RSI itself but misunderstandings about its use. To succeed with RSI formula, remember:

1. RSI measures momentum, not reversal points.
2. Don’t blindly follow 70/30; analyze the trend first.
3. The 50 line is as important as 70/30.
4. Divergence and Failure Swings are powerful signals.
5. Combine RSI with other tools, don’t use it in isolation.

With proper understanding and disciplined trading, any trader can turn RSI from a confusing indicator into a powerful weapon.