Relative Strength Index Indicator Explained
- The RSI is probably the most popular trading indicator
- If the RSI is less than 30, the market is oversold
- If the RSI is 70 or greater, the market is assumed to be overbought
What is the RSI
In Forex trading, technical analysis is one of the best methods for predicting future price movements. We compare historically with now moment perspective.
How Does the RSI Work
One of the essential tools in technical analysis is the RSI. Why is it so important to trade with the RSI indicator? The RSI is an integral part of technical analysis.
Why is the RSI Important for Traders
We use the RSI for three main reasons:
- The trend is your friend
Being a leading indicator, the RSI follows the trend. Best trades are always in the trend direction as smart money leads the market. The trend is your friend is a well-known Forex saying, and the RSI confirms it.
- History repeats itself
What happened in the past is going to happen in the now moment. It is one of the main postulates of Forex trading, and the RSI is the leader in that way. It’s a leading indicator that leads the price.
- Leading indicator leads the price.
The RSI is a leading indicator. It has been prevalent due to the use of the RSI divergence and trend following strategies. Coupled with a lagging indicator, a good leading indicator such as the RSI can match a powerful Forex trading system.
The Deeper Insight into the RSI
What is the RSI indicator? The basic premise is that the RSI oscillates between the overbought and oversold levels, and it moves up and down. J.Welles Wilder created the RSI.
If the RSI is 70 or greater, the instrument is assumed to be overbought (a situation in which prices have risen more than market expectations). An RSI of 30 or less is taken to signal that the instrument may be oversold (a situation in which prices have fallen more than the market expectations).
Contrary to many opinions, the RSI is a leading indicator.
To attach the indicator to your MT4 chart, drag and drop it to the main chart window.
There are many ways to use the MT4 RSI indicator, and we will explain how to use the RSI in the best possible way.
RSI OBOS Levels
If the RSI is less than 30, the market is oversold, and the price might eventually increase. Once the reversal is confirmed, traders can place a buy trade.
Conversely, if the RSI is more than 70, it means it’s overbought, and the price might soon decline. After confirmation of the reversal, traders can place a sell trade.
The 50 level is the midline separates the upper (Bullish) and lower (Bearish) territories. In an uptrend, the RSI is usually above 50, while in a downtrend, it is below 50.
RSI Two Period Divergence
Apply a short five period RSI (RSI 5) over the more extended (default) 14 period RSI (RSI 14) and watch for crossovers.
With the RSI 14, there are times when the market does not reach the oversold or overbought levels before shifting direction. In a shorter period, RSI is more reactive to recent price changes to show early signs of reversals.
When the RSI 5 crosses above the RSI 14, it means that recent prices are getting higher. A buy signal is generated. The 5 vs 14 cross should happen when five periods (blue) is oversold (below 30).
When the RSI 5 crosses below and becomes lower than the RSI 14, recent prices are declining. It’s a sell signal. 5 vs 14 cross should happen when 5 period (blue) is overbought (above 80).
Experienced traders find that their trading performance greatly benefits from combining RSI trading strategy with Pivot Points.
The RSI can easily create trend lines. If we put the trend lines at the bottoms or the tops of the RSI indicator, we can measure a potential breakout. The RSI trend lines can also give us entry signals.
RSI Classic Divergence
A bullish RSI divergence forms when the price is making a lower high, and the RSI is making a higher low.
The RSI bearish divergence forms when the price forms a higher high, and at the same time, the RSI is making a lower high. The RSI divergence creates a perfect signal for a reversal entry.
We prefer using higher timeframes (H4, Daily) for trading RSI divergence.
Using these principles, you can get various rsi indicators to buy and sell signals. The best RSI indicator is the default one found on our MT4 Platform.
What Did We Learn from the RSI
Using the Forex RSI indicator is simple, and novice traders often begin trading without proper knowledge of the RSI indicator.
Because of that, the RSI has become one of the most widely misunderstood Forex indicators. Once understood and correctly applied, the RSI can indicate whether prices are trending, when a market is overbought or oversold, and the best price to enter or exit a trade.
It can also reveal what trading time frame is most active and provides information in determining key price levels of support and resistance.
The RSI is an excellent indicator for Forex trading, and it can be a reliable tool for most Forex and CFD traders.
Detailed Info on RSI Indicator
What is the RSI formula?
The formula for the FX RSI indicator takes two equations that are involved in solving the formula. The first component equation obtains the initial Relative Strength (RS) value, which is the ratio of the average UP closes to the average DOWN closes over ‘N’ periods represented in the following formula:
RS = Average of ‘N’ day’s closes UP/Average of ‘N’ day’s closing DOWN
The actual RSI value is calculated by indexing the indicator to 100 using the following formula: RSI = 100 – (100 /1 + RS).
Can we trade divergence with RSI
Yes. A bullish divergence occurs when the underlying security makes a lower low and RSI forms a higher low. RSI does not confirm the lower low and this shows strengthening momentum. A bearish divergence forms when the security records a higher high and RSI forms a lower high
Cheers and safe trading,