RSI Indicator: How to Spot Overbought Stocks

Part 1: What is the RSI?

The Relative Strength Index (RSI) is a momentum oscillator that measures the speed and change of price movements. It oscillates between zero and 100. It was developed by J. Welles Wilder in his seminal 1978 book, New Concepts in Technical Trading Systems -- the same book that introduced the ATR (Average True Range) and Parabolic SAR. Wilder was an engineer, and he designed the RSI to solve the problem of "whipsaws" in trend-following systems.

Think of a car speeding up a hill. As it climbs, the engine works hard (Momentum increases). Eventually, if the hill is too steep, the car might keep moving forward, but it slows down (Momentum decreases). The RSI measures this internal strength. It tells you if the current price move is sustainable or if it is running on fumes.

The Calculation (For Geeks)

You don't need to calculate this manually (computers do it), but understanding the math helps you trust the tool.

Part 2: The Biggest Myth (Don't Do This!)

So, if we can't trade the levels blindly, how do we use it? We look for failure. We look for discrepancies.

Part 3: The Secret Weapon - Divergence

Divergence is the single most reliable signal in technical analysis. It happens when the Price tells a lie, but the RSI tells the truth. It represents a disconnect between price action and momentum.

Part 4: Advanced Strategy - Swing Failure Pattern (SFP)

Commonly used by professional crypto and forex traders to snipe exact tops. This setup focuses on the RSI breaking back into the range.

Part 5: Advanced RSI Theory - Andrew Cardwell

Most traders stop at Wilder's 70/30 levels. But Andrew Cardwell, the "RSI Student," revolutionized the indicator by discovering that the ranges shift depending on the trend.

Pro Tip: Use the "Range Shift" to identify trend changes. If the market has been in a bear trend (peaking at 60), and suddenly RSI pushes to 75, the bear market is over. A new bull trend has begun.

Part 6: RSI Trendlines & The Connie Brown Shift

A little-known secret of RSI is that you can draw trendlines directly on the indicator window, just like you do on price charts.

Part 7: Combining RSI with Moving Averages

No indicator should be an island. The best strategy is to combine the "Trend" (Moving Averages) with the "Momentum" (RSI).

This strategy filters out the bad "Oversold" signals (catching a falling knife) by ensuring you are trading in the direction of the dominant trend.

Part 8: Building an RSI Algo Bot

For the developers reading this, RSI is one of the easiest indicators to automate because it has clear, mathematical bounds. Here is a simple logic structure for a mean-reversion bot:

// Python / Pseudo-code Logic
def evaluate_rsi_strategy(price_data, period=14):
    rsi = calculate_rsi(price_data, period)
    current_rsi = rsi[-1]
    prev_rsi = rsi[-2]
    
    # Buy Signal: Crossing UP above 30
    if prev_rsi < 30 and current_rsi > 30:
        return "BUY"
        
    # Sell Signal: Crossing DOWN below 70
    elif prev_rsi > 70 and current_rsi < 70:
        return "SELL"
    
    return "HOLD"

Note: While this code works, it is profitable only in ranging markets. In trending markets, it will lose money. To fix this, add a trend filter: if price > 200_sma and rsi < 30: Buy.

FAQ: Mastering RSI