How to Trade Having an RSI Indicator
Even the RSI, or Relative Strength Index, is just another versatile and favorite index. It may be employed for practically any marketplace as well as on any given time period. The normal setting is 14 sessions, however, traders frequently fix this to anywhere from two to 25 based on what they wish to make use of it. To determine extreme short-term movements several traders put it between two and 6, while other traders place it into 2 1 and put it to use for a trend index. For almost every other purposes it generally place to 14.
Calculation of The Relative Strength Index
You probably won’t ever need to calculate the RSI yourself, but it’s useful to know how it is derived. The RSI compares the size of average positive amount movements and average negative amount movements over the period being studied. There are three steps to calculating the indicator.
First, the average gains and losses are calculated over a number of periods being studied:
Average gain = Sum of all positive amount movements over last n periods/number of positive movements in last n periods.
Average loss = Sum of all negative amount movements over the last n periods/number of negative movements in last n periods.
Next, the two are compared by dividing the average gain by the average loss:
RS=Average Gain/Average loss
Finally, the result is normalised using the following formula:
RSI = 100-(100/1 RS)
The result is an index that oscillates medially 0 and 100, climbing when the ratio medially average gains and average losses rises and falling when the ratio falls.
6 Different Ways You Can Use the RSI
The RSI can be used in several ways as you will see beneath. However, it should almost always be used with other indicators like moving averages or a MACD, and not in isolation. The RSI can also be used as a tool to help you confirm or time entries and exits.
Simple Confirmation for Trade Entries
Very simply, an RSI can be used to confirm trade entries for other strategies. If you are entering a long position based on moving averages, trend lines or a MACD indicator, you can wait for the RSI to cross above 50 to prove there is some momentum behind the amount. Likewise, for short trades, you can wait for the RSI to fall beneath 50.
Overbought and Oversold
The RSI is one of several oscillators that traders use to identify overbought and oversold levels. Prices become oversold when the RSI falls beneath 30 and overbought above 70.
The following 4-hour chart of the EURUSD pair shows how an oversold RSI reading combined with 50 and 100-period moving averages offered a profitable entry point within the uptrend.
EURUSD 4-Hour Chart
An RSI can help you time your exit for positions that have been entered using other methods. For long positions, you can wait for the RSI to rise above 70, and then exit as soon as it drops back beneath 70. This will help you exit your position when the amount is overbought and momentum is showing signs of slowing. For short positions, you would wait for the RSI to fall beneath 30, and then rise back above that level.
The following chart illustrates how well this method of exiting a trade can work.
Like most oscillators, an RSI can be used to warn of pending reversals or retracements. If the amount makes a higher high, while the RSI makes a lower high, a bearish reversal or retracement might be developing.
If the amount makes a lower low but the RSI makes a higher low, amounts may soon rise. An example of this is shown on the following daily chart of GBPUSD. Divergence does not indicate exactly when the move will occur, or its magnitude, so amount action needs to be watched carefully for confirmation.
GBUSD Daily Chart
Trend lines can also be drawn on the RSI indicator, with a break of the trend line indicating a change in the direction of momentum. Trend lines on the RSI and amount chart can also be combined. If trend lines on both the RSI and amount are broken there is a higher probability of the amount following through, than if only one is broken.
Scalpers and short-term counter-trend traders often use a 2-period RSI to identify extreme amount moves. They will usually use more extreme levels like 90 or 95 for overbought and 10 or 5 for oversold. Trades are then entered in the opposite direction of the move, and positions are exited once the RSI crosses above or beneath 50, or when the amount reaches the midpoint of the trading range. Tight stop losses need to be used with this method as these trades don’t work outside, and also extreme moves may persist for quite a while. The subsequent 15-minute graph for GBPUSD exemplifies how this may be implemented.
GBPUSD 1-5 – Minute Chart
As you may see, that the RSI is just a rather elastic index. Because it might be employed for many goals, it might be utilised in host to other signs, resulting in an uncluttered graph design. But it shouldn’t be utilised in isolation and can be used in combination with moving averages, trendlines, or perhaps a MACD index.