The RSI

This indicator (aka Relative Strength Index) aims at establishing a reference scale independently from the stock prices levels themselves. As the RSI has boundaries (0 and 100), it then becomes very easy to determine overbought and oversold areas. Thus, the RSI is one of the most commonly used counter-trend indicators.
It is based on the average of rises and drops of a stock, with the formula :


RSI = 100 – [100 / (1 + RS)]

where RS represents the average of up closes divided by the average of down closes on the considered period.
Consequently, the shorter the studied period, the more volatile the RSI. Depending on trading habits, longer or shorter lengths can thus be used but the most common length is 14 days.
On a graph, lines can be drawn at 30 and 70. A crossing down of 30 indicates that the market is oversold while a crossing up of 70 indicates that the market is overbought.
Just as for the MACD, it is possible to smooth signs given by the RSI by forming two RSI on two different periods. Then, a crossing up of the long-term RSI by the short-term RSI constitutes a buying signal while a crossing down of the long-term RSI by the short-term RSI constitutes a selling signal.
The principle of divergences is also applicable to the RSI, and is more easily applicable than on the MACD, as overbought and oversold areas can legitimately be drawn.
Finally, just as on stock prices themselves, supports and resistances can appear, especially when nearing the neutrality zone (near 50).