RSI (Relative Strength Index)
RSI indicator was developed by J. Welles Wider who was a technical analyst. RSI is another indicator utilized by many Forex traders, which helps you to spot when the market is Oversold or Overbought. RSI is similar to Stochastic because both of them identify Oversold and Overbought conditions in the market.
RSI is scaled from 0 to 100. The structure of RSI is shown below; You can see it labeled on the chart “RSI(14)”.
From the RSI chart, if readings fall between 70 and 100 (70 or higher), it shows the Overbought Market condition. This is a sign that the price would start going down. Some traders explain that an overbought currency pair is a signal that the upward trend is likely to reverse, which means it’s an opportunity to go short (sell).
Also, from the RSI chart, if the readings fall between 30 and 0 (30 or below), it shows the Oversold market condition. This is a sign that the price would start going up.
Some traders explain that an oversold currency pair is a signal that the downward trend is likely to reverse, which means it’s an opportunity to go long (buy).
HOW TO TRADE USING RSI INDICATOR
- Picking potential Tops (Support) and Bottoms (Resistance) whether the market is Overbought or Oversold
Above is a 4-Hour Chart of EUR/USD
If you look at the main chart, you will notice that EUR/USD has been in an upward trend from June 18 to June 25 according to the date on the chart. The price increased from 1.11760 to 1.14040, rising by 228 pips over the course of the week.
On June 25, the price was already above 1.14000 handle. If you look at the RSI Indicator, you would see that the RSI is above 70, indicating that there might be no more sellers in the market and that there might be a reversal in trend.
As you can see from the RSI Indicator, Price then reversed and started going down over the next couple of weeks.
- Using RSI to determine the Trend
If you observed a trend is forming, take a short look at the RSI and have a look at whether it is above or under 50.
Some people will be wondering where the 50 mark is, don’t panic because I’m going to show you how to locate it.
To see the 50 mark, use your crosshair cursor (crosshair cursor is located at the top right corner of your mt4).
If you click on that “+” sign, you would activate the crosshair cursor and after clicking on it, you would bring (drag) it down to the RSI indicator window. It would now show you where the 50 mark is.
Though, with experience and practice, you would not need that crosshair cursor again. With your eyes, you would easily gauge if the RSI is above or below 50.
Uptrend: When you see the RSI line cross the centerline (50 mark) and starts going upward (If there is movement of the RSI line from above the centerline to below), it has further confirmed to you that this market is actually in an uptrend and it’s not just ranging. After you have observed this movement, you can place your BUY order or relax properly if you are already buying.
At the beginning of the chart below, we can see that a possible uptrend was forming. To avoid fakeouts, we can wait for RSI to cross above 50 to confirm our trend. As RSI passes above 50, it is a good confirmation that an uptrend has actually formed.
Downtrend: If the RSI line crosses the centerline (50 mark) and starts moving downwards (If there is movement of the RSI line from above the centerline to below), it’s a sign that the market is truly in a downward trend. Then, you can confidently place your SELL order.
At the beginning of the chart below, we can see that a possible downtrend was forming. To avoid fakeouts, we can wait for RSI to cross below 50 to confirm our trend. As RSI passes below 50, it is a good confirmation that a downtrend has actually formed.
Note: To avoid Fakeouts, never trade with only one indicator. Always use 2 to 3 indicators to confirm a trend.
Other indicators you can use together with RSI to confirm a trend are;
- MACD (Moving Averages Convergence Divergence)
- Moving Averages (MA)