RSI indicates temporarily overbought or oversold market conditions most frequently. It is possible to design a forex trading strategy that takes advantage of RSI indicators that indicate an overextended market will retrace.
An RSI reading above 70 indicates that a market is overbought, while readings under 30 indicate oversold conditions. Some traders and analysts prefer the more extreme reading of 80 and 20.1.
Due to its weakness, the RSI can give false signals when it repeatedly spikes up or down due to sudden, sharp price fluctuations.
When compared with other signals, however, those spikes or falls may indicate an entry or exit point if they prove to be congruent with other signals.
RSI Indicators and Signals
Overview
Indicators such as the RSI (Relative Strength Index) are widely used to:
- A measure of price movement speed (velocity).
- Measures the magnitude of price changes (direction).
It calculates a value based on the cumulative strength and weakness of prices over a specified period set in the input Price, which by default is 14 days.
Candlesticks with different closing values are used to calculate the RSI. Finally, an index is derived from these two sums.
The RSI scale ranges from 0 to 100. Price movements have less momentum when the RSI is closer to zero. On the other hand, the opposite is also true. Higher RSI values indicate stronger momentum.
With the indicator, you can easily monitor the strength and weaknesses of the market both in the present and in the past. In addition, price movement can be accurately predicted with the RSI.
The RSI have pinpointed market turning points (reversals) in the past.
Indicator structure of the RSI
An American mechanical engineer developed the RSI indicator named Welles Wilder. This indicator usually appears separate from your chart at the bottom.
It is made up of a single line that fluctuates between 0 and 100. There are three main zones:
- Oversold area: 0-30
- Neutral Zone: 30-70
- Overbought Area: 70-100
These three areas create different signals on the chart as the RSI line moves into and out of them.
Calculation of the RSI line
In most cases, 14 periods is the default setting for RSI. We will now study the RSI formula in further detail: First, let us take a look at the 14-period setting for the RSI:
The RSI is calculated as (100 – 100 / (1 + RS))
In the formula above, RS is Relative Strength. Therefore, calculating the Relative Strength (RS) seems simple, but we also need to subtract the work done. To do this, follow these steps:
The RS is calculated by dividing (14 EMA on the last 14 up bars) by (14 EMA on the last 14 down bars).
After determining its value, you can apply the RS value in the first formula. Then, RSI will be determined accordingly.
Changing the periods that the RSI considers will have the same effect. For example, the second formula will look like this if you use a 20-period RSI:
The RS is calculated as (20 EMA on the last 20 up bars) / (20 EMA on the last 20 down bars).
Using the result of the first formula, you can determine RSI.
How does the RSI indicator work?
It is possible to adjust the traditional levels to fit the security situation better. For example, when the RSI crosses 70, it is considered overbought. When it crosses below 30, it is considered oversold. You may want to adjust an asset’s overbought level to 80 if it is repeatedly reaching the 70 levels.
The RSI may remain in overbought or oversold territory for extended periods during strong trends.
Chart patterns such as trend lines and double tops and bottoms may not show up on the underlying price chart with RSI. So check also for resistance and support on the RSI.
RSIs mark a bull market or uptrend in the 40 to 90 range and the 40-50 zone as support. Conversely, the RSI tends to stay between 10 and 60 during a downtrend or bear market, with resistance occurring between 50 and 60.
A security or market’s underlying trend will determine the RSI settings and range.
RSI divergence can signal a price reversal if underlying prices make a new high or low, but the RSI is not confirming it. When the RSI reaches a lower high and then descends below a previous low, a Top Swing Failure has been.
An upside above the previous high follows a higher low, known as a Bottom Swing Failure.
Installation instructions for extreme RSI indicator
- This indicator was developed for MT4 and can be downloaded here.
- In your Metatrader expert/indicators/indicators directory, copy Extreme RSI Indicator for MT4.mq4.
- Begin Metatrader 4 or restart it.
- You should now be able to test your MT4 indicators.
- In your Metatrader 4 Client, search for “Custom Indicators” in your Navigator.
- In the MT4 chart, right-click on RSI Indicator Extreme.mq4.
- Join the chart
- Modify the settings or press ok
- The MT4.mq4 chart shows the indicator Extreme RSI Indicator
How to remove extreme RSI indicators from your MetaTrader chart?
- Your MetaTrader 4 Client must be configured to run the indicator on the chart you selected
- Right-click in top of the Chart
- “Indicators list” will display in front of you.
- Choose the indicator and then delete it.
Forex RSI advantages
The RSI’s popularity as a forex indicator comes from its distinct advantages as a research and evaluation tool. Among them are:
- Mathematical formulas are used. Unlike some other technical indicators, RSI is simple enough that traders may easily compute it by hand. Traders may find comfort in knowing precisely how RSI-based insights are derived, even though it’s always better to use a live chart that tracks RSI visually.
- Chart analysis is easy with this program. With its clearly defined overbought and oversold levels, the RSI indicator is easy to use – even for novice traders – while remaining accurate and intelligent enough for more experienced traders to continue relying on it.
- Trade opportunities are identified using simple notifications. Rather than relying solely on RSI to initiate trades, most traders use them to signal potential trade opportunities.
- So, traders will set notifications when overbought or oversold conditions develop for currency pairs. Traders can stay informed of the changing forex market trends without missing out on new opportunities.
RSI in Forex: What are the drawbacks?
However, despite its value, RSI is not a foolproof tool for forex traders. Although misuse of RSI can exacerbate many of its disadvantages, there are a few things you need to keep in mind, including:
- Trading or confirming trades with RSI isn’t recommended. However, forex traders frequently use RSI to identify trade opportunities and prompt further research and analysis. RSI identifies overbought or oversold conditions well, but it lacks the context necessary to determine whether or why these conditions are good trading opportunities.
- Reversals in the price of commodities can occur at any time. The RSI can accurately predict price reversals, but on the other hand, conditions can remain overbought or oversold for days-far beyond what some traders look for.
- Forex trends can make RSI less accurate. The RSI may still be useful in strong trends, but caution should be exercised when using it.
How to read an RSI graph?
An asset that moves above 70 on the RSI’s overbought or oversold line indicates it is overbought, and a move below 30 is an indication that it is oversold.
In the case of the RSI moving below 30 then crossing back over the oversold line, it’s considered a bullish indicator (buy), indicating that prices will increase.
In contrast, when the RSI dips below this overbought line after moving initially above 70, it signals a bearish (sell) signal, indicating that the price is about to drop.
Read RSI Swing Indicators & Signals
Which is the best RSI to buy?
In Wilder’s framework, the RSI identifies oversold and overbought levels in the oscillator at thirty and seventy levels. Therefore, when RSI reaches over 70, you should sell the financial asset bought too much.
When RSI falls below 30, you should buy the financial asset that has been sold too much. There are, however, other options.
What is the significance of a high RSI? RSI levels above 70 are considered a sign to keep buying by some trend-following strategies. This time, the RSI is used as a guidance tool, not as a trigger for an entry into a trade.
Successful day traders have used the definition of oversold and overbought to the 20 and 80 levels, or even other levels, to increase the accuracy of buying and selling triggers from RSI indicators.
These price extremes are less frequent than 30 and 70, thus offering the best trading signals in theory. However, it means missing some potentially good trading opportunities if 20 and 80 are used for RSI.
How do you use the RSI strategy?
In addition to oversold and overbought levels, Wilder recommended RSI indicator trading strategies that incorporated divergence. But, again, it is best to choose the indicator settings based on an individual trader’s experience.
It would help if you experimented with different settings to determine which works best for you. As an example of developing your trading system, here is one RSI trading strategy you can use as a guide.
(90/1) RSI (2-period)
Larry Connors developed this RSI strategy to identify periods when the short-term trend is vastly oversold during an uptrend in the market or when the short-term trend is overbought during a downtrend overall.
Connors uses a much more sensitive timeframe at the lower end of the RSI – 2 periods – since it is intended for a trend entry point. Due to the short timeframe of 2, Connors uses the 90 and 10 levels instead of the 70 and 30 levels to filter false signals.
This trading strategy involves buying dips and selling rips.RSI can be used in the following ways:
- A 200-period SMA can be used to determine the direction of prices.
- Change the RSI settings to 2 periods and add the indicator.
- Oversold and overbought levels should be adjusted to 90 and 10, respectively.
- A buy signal is generated when the price exceeds 200 SMA and RSI (2) < 10
- In the RSI indicator, a sell signal occurs when price * 200 SMA and RSI (2) are greater than 90
Use of RSI Indicator in MT4
RSI in relation with other indicators
The key to understanding RSI signals is understanding trend direction. Therefore, moving average convergence divergence (MACD) is commonly used with this indicator and other trend-following tools.
MACD‘s identification of divergence from price coupled with RSI can confirm overbought conditions. A popular indicator for identifying a trade opportunity is the alignment of these two indicators.
The average directional index (ADX) can also signal overbought conditions, particularly if it is trending in the direction of a retracement.
Related questions: FAQs
1. How do I choose a good RSI indicator?
RSI readings of 30 or below indicate oversold or undervalued conditions. RSI readings may fall into bands or ranges during trends. In an uptrend, the RSI should frequently exceed 70 during an uptrend.
2. What is the best time to buy RSI?
It is generally good for investors to follow a few simple rules when using RSI. A low RSI level, typically below 30 (red line), indicates oversold conditions, signalling a potential buy opportunity. On the other hand, a high RSI (green line) indicates overbought conditions, indicating a sell signal.
3. When setting the RSI period, what should you take into account?
Determine the price trend by calculating the 200-period simple moving average (SMA). Next, select the two-period RSI indicator. Overbought and oversold levels should be adjusted to 90 and 10, respectively.
4. Swing trading with RSI good or bad?
Swing traders rely on momentum indicators to identify potential oscillations within broader trends. The relative strength index (RSI) is perhaps the most widely used indicator of whether the market is overbought or oversold – and, therefore, whether another swing might be imminent.
5. How long does the RSI measure?
On average, RSI is measured on a 14-day timescale, measuring from 0 to 100, with the high and low levels being 70 and 30, respectively. In alternately shorter or longer outlooks, shorter and longer timeframes are used.
Bottom line
This indicator will work well if you are trading in an environment with wide swings. RSI tends to be overbought or oversold in support and resistance areas because these are the areas where support and resistance are located in the range.
As a result, this indicator should not be used in trending market conditions since the signals it produces are generally counter-trend signals. Signals with low probability may often lead to losses.
