Overbought in context

RSI, the Relative Strength Index, compares the strength of recent gains against recent losses and converts the result into a value between 0 and 100. The traditional thresholds are 70 and 30: above 70 is labelled the overbought zone, below 30 the oversold zone. Those labels are the most misunderstood part of the indicator, because "overbought" sounds like "it has risen too much, so it must fall". In a strong uptrend, however, RSI can sit above 70 for weeks while price keeps climbing, and in a hard decline it can crawl below 30 for just as long. The correct reading depends on context: in a sideways market extreme RSI values coincide with the edges of the band and are read together with the possibility of a reaction, while in a trending market an extreme value usually reflects the strength of the trend rather than its exhaustion. Before looking at the indicator, then, you ask the level 2 question: is this market trending or sideways? The common misreading takes the label as a verdict detached from context. The lesson for risk literacy: an indicator has no meaning until you know what state the market is in.

This content is educational information, not personalised investment advice. The chart examples are illustrative.

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