The Relative Strength Index (RSI) is a very famous overbought/oversold (OB/OS) forex indicator. This oscillator was created by Welles Wilder Jr. and illustrated in his book “New Concepts in Technical Trading Systems“.
RSI is an essential strength index which is revised on a daily basis by the rate by which the market price increased or dropped. It is largely used to reveal where the price has reached its highest or lowest point. A high RSI takes place when the price has been ranging sharply and a low RSI takes place when the price has been selling off aggressively. Relative Strenght Index is indicated as a percentage between 0 and 100%.
RSI Indicator’s main feature makes it change slower when it reaches increased overbought or oversold levels, and then moves back very rapidly when the market starts even a minimal correction. This drives the RSI back to more normal levels and advises that the price trend might resume.
Wilder original RSI indicator setting was based on 14-day period. Also the 9-day and 25-day RSIs are largely used in forex trading. The fewer days used to determine the RSI, the more volatile the indicator.
RSI Trading Signals
The prevalent method of interpreting the RSI indicator is to seek a divergence in the market when the security is gaining a new high, but the RSI is not reaching to exceed its previous high. This divergence is an signal of an impending reversal. When the RSI then moves down and slips below its latest trough, it is said to have created a “failure swing”. The failure swing is considered a verification of the upcoming reversal.
Different signals are involved in trending and ranging situations. The main signals are acquired from overbought and oversold areas, divergences and failure swings.
- Overbought level is set at 70 and Oversold level at 30.
- Buy when RSI moves below the 30 level and increases back above it or in a bullish divergence when the first trough is below 30.
- Sell when RSI increases above the 70 level and decreases back below it or on a bearish divergence when the first top is above 70.
- Failure swings give confirmation to other signals.
- Only take into account signals in the same direction of the main trend.
- Buy during a positive trend, when RSI decreases below 40 and increases back above it.
- Sell in a negative trend, when RSI increases above 60 and falls back below it.
- Use a trend indicator to determine exit points.
- Take profits on divergences. Relative Strength Index divergences are not powerful enough to give profitable signals in a trending market, so always use a trend indicator.
RSI Indicator Formula
RSI = 100 – 100/(1 + AB*)
*where AB = Average of x days’ up closes / Average of x days’ down closes.
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