RSI (Relative Strength Index)
The Relative Strength Index (RSI) is a momentum oscillator measuring the speed and change of price movements on a scale of 0 to 100 to identify overbought and oversold conditions.
Detailed Explanation
Developed by J. Welles Wilder Jr. in 1978, the RSI is one of the most widely utilized technical momentum indicators on NEPSE. Calculated over a standard 14-period lookback, the RSI oscillates between 0 and 100. Traditionally, an RSI reading above 70 indicates that an asset is "Overbought" (extended upside, ripe for a pullback or consolidation), while a reading below 30 indicates that it is "Oversold" (extended downside, potential buying opportunity). Crucially, seasoned NEPSE traders also look for "Divergence"—situations where the stock price prints a lower low but RSI prints a higher low, signaling an impending upward trend reversal.
Why It Matters to You
Buying a stock when its RSI is sitting at 85 or 90 during a parabolic frenzy exposes you to high risk of an immediate correction. RSI helps you avoid chasing overextended rallies and spot exhausted downtrends.
Formula & Calculation
RSI = 100 - [100 / (1 + (Average Gain / Average Loss))]
- Average Gain = Sum of gains over 14 periods divided by 14
- Average Loss = Sum of losses over 14 periods divided by 14
If Average Gain = 2.0 and Average Loss = 1.0, RS = 2.0. RSI = 100 - [100 / (1 + 2)] = 100 - 33.33 = 66.67.
Where It Is Commonly Used
- Momentum confirmation
- Trend exhaustion identification
- Divergence reversal setups
Key Advantages & Limitations
Key Advantages
- Exceptional at identifying momentum shifts and divergence
- Objective mathematical formula
- Universally built into all trading software
Limitations & Risks
- Can generate false overbought signals in runaway trending markets
Common Misconceptions & Beginner Traps
As soon as RSI crosses above 70, you must sell immediately.
In a powerful bull trend, an asset can remain overbought above 70 for extended periods while doubling in price. Always combine RSI with trend structure.
Nepal Financial & Regulatory Context
During intense NEPSE bull runs, momentum can keep individual speculative stocks in overbought territory (RSI 75-85) for weeks. In strong trends, traders use 40 as dynamic bull support.
Real-World Practical Scenario
Detecting Bullish Divergence on NEPSE Index. NEPSE drops to 1,850 in month 1 with Daily RSI at 24. Market rallies, then drops again to 1,800 in month 3 (lower price low). However, Daily RSI on the second low only drops to 32 (higher RSI low). Confirmation: Bullish Divergence detected
Sellers are exhausted; market launches a multi-month recovery rally.