Relative Strength Index: What Is RSI and How To Use It in Stock and Options Trading
If you’ve ever looked at a trading chart and wondered what that squiggly line underneath the candlesticks means, you’re not alone. That’s likely the Relative Strength Index (RSI) — one of the most widely used technical indicators for identifying potential reversals, momentum shifts, and trading opportunities in stocks and options.
In this guide, we’ll break down what RSI is, how it works, and how you can use it like a pro to elevate your trading game. Let’s jump in.
What Is RSI?
The Relative Strength Index (RSI) is a momentum oscillator developed by J. Welles Wilder. It measures the speed and magnitude of recent price changes to determine if a stock is overbought or oversold.
RSI is plotted on a scale of 0 to 100, with typical thresholds set at:
70 and above: Overbought (potential sell signal)
30 and below: Oversold (potential buy signal)
🧮 RSI Formula
For those who love the math:
RSI = 100 – (100 / (1 + RS))
where RS = Average Gain / Average Loss over a specific period (typically 14 periods)
Don’t worry — most platforms like TradingView, ThinkorSwim, and Webull handle this for you.
How to Read the RSI Indicator
Above 70: The stock might be overextended. This doesn’t guarantee a drop, but it signals the asset may be due for a pullback.
Below 30: The stock could be undervalued in the short term — possibly gearing up for a bounce.
Between 30–70: Neutral zone. Price is considered stable, or it’s consolidating.
💡 Tip: RSI works best in ranging markets. In strong trends, RSI can stay overbought or oversold for a while.
Best RSI Settings for Trading
Default setting (14): Ideal for most traders.
Shorter RSI (7-10): More sensitive, good for fast-paced day trading.
Longer RSI (21-30): Smoother and slower, better for swing or position trades.
When trading options, especially short-term contracts, many traders opt for a shorter RSI setting to catch quicker momentum shifts.
How To Use RSI in Stock and Options Trading
Identify Overbought and Oversold Conditions
Buy signals when RSI < 30 (especially if price forms a bullish pattern)
Sell signals when RSI > 70 (watch for topping behavior or bearish divergence)
Spot Divergences
When price makes a new high or low that isn’t confirmed by RSI, it can hint at a reversal:
Bearish Divergence: Price makes a higher high, RSI makes a lower high → potential drop
Bullish Divergence: Price makes a lower low, RSI makes a higher low → possible bounce
This is especially useful for swing trading options with expiration windows of 1–4 weeks.
Combine RSI With Other Indicators
Moving Averages: Use RSI with the 50-day or 200-day MA to confirm trends
MACD: Layering RSI with Moving Average Convergence Divergence can enhance accuracy in volatile environments
Support/Resistance: RSI signals near key levels can carry more weight
RSI Trading Strategy Example
Let’s say you’re watching $AAPL and notice:
RSI just dropped to 28
Price is near previous support
A bullish hammer candlestick is forming
This setup could justify a bullish options trade like a call debit spread or a naked call if you’re confident. Set a stop-loss just below support and a target around the next resistance level.
Pro Tips for RSI Trading
Relative Strength Index isn’t a standalone signal. It works best when combined with price action and other technical tools.
Don’t treat 70/30 levels as hard rules — sometimes you’ll see reversals at 60 or 80.
Consider the overall trend. In a strong uptrend, RSI might stay above 50 for weeks. In a downtrend, RSI might never touch 70.
RSI in Trending vs. Ranging Markets
Trending Market: Use RSI midline (50) as a trend filter.
Above 50: Bullish bias
Below 50: Bearish bias
Ranging Market: Focus more on the 70/30 extremes for mean reversion trades.
Understanding the context of the broader market is key. Options traders especially should pair RSI signals with volatility metrics like IV Rank or VIX.
Final Thoughts: Should You Use RSI?
Absolutely — but use it wisely. RSI is powerful, especially when combined with strong technical levels or patterns. It can help you:
Time entries and exits
Spot hidden reversals
Add confidence to your options plays
Whether you’re swing trading SPY puts or day trading TSLA calls, RSI is a tool you want in your arsenal.
Frequently Asked Questions (FAQ)
What is a good RSI for buying a stock?
Generally, an RSI below 30 may indicate a good buying opportunity — but always confirm with other indicators or patterns.
Is RSI good for day trading?
Yes. Many day traders use a shorter RSI (7 or 9) to catch quick intraday moves.
Can RSI be used for options trading?
Definitely. RSI helps pinpoint short-term overbought/oversold conditions, which is critical for timing options entries.
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