Relative Strength Index

Relative Strength Index, or RSI, is one of the most popular technical indicators among traders. It was developed by J. Welles Wilder in 1978 to measure the speed and the change of price movements. The indicator also helps to determine the overbought/oversold state of the market in order to buy low and sell high.

How to interpret Relative Strength Index:

The readings of the indicator fluctuate between 0 and 100. You can also add a middle line at 50. If the RSI is above this point, momentum is considered up and there’s more sense to look for opportunities to buy. When the RSI drops below 50, it’s a sign of a new bearish market trend, so consider opening sell trades.

The market is overbought or oversold

Like other oscillators, the RSI helps to tell when the asset is overbought or oversold. For the RSI, you need to watch the levels of 70 and 30. If the RSI rises above 70 bound, it means that the market is overbought and may correct down. If the RSI falls below the 30 line – the asset is oversold and may retrace to higher levels.

Notice, however, that this approach is not suitable for trading in strong trends when the RSI may stay overbought or oversold for long periods of time. If you have evidence that there’s a strong trend in the market, consider selling when RSI is oversold in a downtrend, and buying when RSI is overbought in an uptrend.

All in all, the quality of RSI signals increases when you follow only those signals that are in the direction of the trend when the indicator leaves critical levels. For example, you can buy during an uptrend when RSI gets above 30.

The market reversal

Moreover, the divergence between RSI and price may warn of the market reversal. When the new high of the price is not confirmed by the new high in the RSI, it’s a bearish divergence, which is a negative signal. When the price forms a lower low but the minimum of RSI is higher than the previous one, it’s a divergence in favor of bulls.

The RSI is often used in combination with another oscillator, the MACD. While the RSI measures price change in relation to recent price highs and lows, the MACD measures the relationship between two EMAs. Together the RSI and the MACD represent a powerful combo.

Build your strategy on RSI::

Before we consider RSI trading strategies, it’s worth beginning with the small definition of the RSI.

RSI (Relative Strength Index) is one of the oscillator indicators that is widely used by traders to determine reversal points. The main idea that you should keep in mind implementing different trading strategies is “if RSI rises above 70 bound, it means that the pair is overbought. If RSI falls below the 30 line – the pair is oversold.”

Let’s consider 2 simple trading strategies that you can use in your daily trading.

Strategy #1

Criteria:

• Currency pair – any
• Timeframe – H4
• RSI – Period 8, apply to “Close”, levels: 30, 40, 50, 60, 70

BUY Steps:

1. When RSI crosses the 50 level bottom up, place Buy Stop pending order 15 pips above the candlestick where the cross happened. Don’t forget about Stop Loss! Place it at the local minimum. And remember that if the index crossed the 50 level back, you should close the position.
2. As soon as the index crosses the 60 level, place the second order. The Stop Loss should be placed at the local minimum as well.
3. When is it time to close the position? As soon as the RSI breaks the 70 level upside down.

SELL Steps:

When RSI crosses the 60 level downside, place a Sell Stop pending order 15 pips below the candlestick where the cross happened. The Stop Loss will be at the local high.

When the index breaks below the 50 level, place another pending order below the candlestick of the cross. Don’t forget about the Stop Loss.

If you come back to the introduction of this article, you will see that 30 line is one of the key levels. So when the index crosses the 30 level bottom up, it’s time to take profit as it’s a signal of the reversal up.

Strategy #2 (the 50th candlestick)

Criteria:

• Currency pair – any
• Timeframe – any
• RSI - Period 8, levels: 20, 80

Steps:

1. Find a pair the 50th candlestick of that is lower than previous 49 ones.
2. Apply the RSI indicator. Check where the indicator crosses the 20 level upside down. Check whether the below 20 RSI corresponds to the 50th Only after both conditions are met, you can move to the next step.
3. Now it’s time to wait for another candlestick that will be lower than the 50th However, it’s important to have a look at the index. The index is supposed to provide a higher signal than the first one (it’s a divergence between the indicator and the price). If these conditions are met as well, we can look for the entry point.
4. The next step is to determine the entry. You should wait for the candlestick that will close above the 50th After that, you can open the position.
5. The next step is very important in any trade. Place the Stop Loss. Have a look at the chart and find a reasonable support level according to the previous price moves. Your Stop Loss should be a little bit lower than the support because the price may reach the support and rebound. But if it doesn’t rebound, risks of the further fall would increase.
6. The last step is to find a take profit level. It’s a golden rule of traders to use 1:3 risk-reward ratio. So if you determined the Stop Loss level, you should count the distance between the entry price and the Stop Loss and place 3 such distances above the entry price. It will be your target.

Tips: all traders know that signals of only one indicator don’t give 100% assurance. It’s always better to combine several indicators. And if you see that another indicator signals the reversal, it’s better to take that signal into consideration and maybe even close the position before the RSI gives a signal.

Making a conclusion, we can say that RSI is one of the most reliable indicators. You even may combine it with other indicators to create your own strategy!

Conclusion

A competent trader should know what the RSI is and how to use it. Make sure that your analysis isn’t built solely on RSI but comprises the study of price action as well as other technical indicators. Remember that the signals of the Relative Strength Index are most reliable when they conform to the long-term trend.

More info about RSI on TradingView