The relative strength index (RSI) is most commonly used to indicate temporarily overbought or oversold conditions in a market. An intraday forex trading strategy can be devised to take advantage of indications from the RSI that a market is overextended and therefore likely to retrace.
Key Takeaways
- The common levels to pay attention to when trading with the RSI are 70 and 30.
- An RSI of over 70 is considered overbought. When it is below 30 it is considered oversold.
- Trading based on RSI indicators is often the starting point when considering a trade, and many traders place alerts at the 70 and 30 marks.
- When the alert is triggered, the trader will examine the validity of a trade.
- The RSI can give false signals, and it is not uncommon in volatile markets for the RSI to remain above the 70 or below the 30 mark for extended periods.
Understanding the RSI
The RSI is a widely used technical indicator and an oscillator that indicates a market is overbought when the RSI value is over 70 and indicates oversold conditions when RSI readings are under 30. Some traders and analysts prefer to use the more extreme readings of 80 and 20.
A weakness of the RSI is that sudden, sharp price movements can cause it to spike repeatedly up or down, and, thus, it is prone to giving false signals. However, if those spikes or falls show a trading confirmation when compared with other signals, it could signal an entry or exit point.
It is not uncommon for the price to continue to extend well beyond the point where the RSI first indicates the market as being overbought or oversold. For this reason, a trading strategy using the RSI works best when supplemented with other technical indicators to avoid entering a trade too early.
Identifying Trading Setups Using the RSI
Here are some steps to implementing an intraday forex trading strategy that employs the RSI and at least one additional confirming indicator:
- Monitor the RSI for readings indicating the market is overbought or oversold.
- Consult other momentum or trend indicators for confirming signs of an impending retracement. For example, if the RSI shows oversold readings, a retracement to the upside is anticipated though not necessarily confirmed.
It is considered good practice to look at initiating a trade looking to profit from a retracement if one of these additional conditions are met:
- The moving average convergence divergence (MACD) has shown divergence from price (for example, if the price has made a new low, but the MACD has not and has turned from a downslope to an upslope).
- The average directional index (ADX) has turned in the direction of a possible retracement.
If the above conditions are met, then consider initiating the trade with a stop-loss order just beyond the recent low or high price, depending on whether the trade is a buy trade or sell trade, respectively. The initial profit target can be the nearest identified support/resistance level.
How Do You Calculate the Relative Strength Index (RSI)?
To calculate the RSI, you must first determine a time frame: one week, two weeks, and so on. From there, you have to sum the average gains and divide the value by the sum of the average losses. This value is the RSI.
What Is a Good RSI Index?
There is not specifically a "good" RSI index. RSI values are indicators that help traders make decisions depending on their goals. RSI values below 30 usually indicate buy signals whereas values above 70 generate sell signals.
What Is a Better Indicator Than RSI?
Different indicators provide different insights. RSI provides insight into overbought or oversold assets. It is not very helpful in identifying trends. The moving average convergence divergence (MACD) indicator is better suited for that.
The Bottom Line
The RSI helps traders understand when a market is overbought or oversold so that they can expect either momentum or a pullback in prices.
If the RSI, along with other indicators, is set up and read correctly, it can help technical traders determine their trading strategies, such as entry and exit points, buying or holding, or shorting positions. RSI can be used in a variety of markets, including stocks and forex.
FAQs
The common levels to pay attention to when trading with the RSI are 70 and 30. An RSI of over 70 is considered overbought. When it is below 30 it is considered oversold. Trading based on RSI indicators is often the starting point when considering a trade, and many traders place alerts at the 70 and 30 marks.
How to trade forex using RSI? ›
One RSI trading strategy used in trending markets would be to wait for the indicator to signal an overbought condition during an uptrend. The trader then waits for RSI to drop below 50, which signals a long entry. If the trend remains in place price will typically recover off this level and move to new highs.
What is the best RSI period for forex? ›
RSI Indicator: Best Settings for Day Trading Strategies
- Short-term intraday traders (day trading) often use lower settings with periods in the range of 9-11.
- Medium-term swing traders frequently use the default period setting of 14.
- Longer-term position traders often set it at a higher period, in the range of 20-30.
While the default period setting for RSI is 14, this may be fine tuned to better match market volatility. The strategic approach typically includes initiating trades when rsi signals hit overbought or oversold levels and strategically placing stop-losses and take-profits to catch peaks and troughs of the market.
When should you buy using RSI? ›
Investors using RSI generally stick to a couple of simple rules. First, low RSI levels, typically below 30 (red line), indicate oversold conditions—generating a potential buy signal. Conversely, high RSI levels, typically above 70 (green line), indicate overbought conditions—generating a potential sell signal.
Is RSI useful in Forex? ›
The relative strength index (RSI) is most commonly used to indicate temporarily overbought or oversold conditions in a market. An intraday forex trading strategy can be devised to take advantage of indications from the RSI that a market is overextended and therefore likely to retrace.
How to use RSI correctly? ›
The basic idea behind the RSI is to measure how quickly traders are bidding the price of the security up or down. The RSI plots this result on a scale of 0 to 100. Readings below 30 generally indicate that the stock is oversold, while readings above 70 indicate that it is overbought.
Which RSI is most accurate? ›
As mentioned before, the normal default settings for RSI is 14 on technical charts. But experts believe that the best timeframe for RSI actually lies between 2 to 6. Intermediate and expert day traders prefer the latter timeframe as they can decrease or increase the values according to their position.
Should I sell if RSI is 90? ›
Low RSI levels, below 30, generate buy signals and indicate an oversold or undervalued condition. High RSI levels, above 70, generate sell signals and suggest that a security is overbought or overvalued.
Does RSI work on a 5 minute chart? ›
It helps identify overbought and oversold conditions, which are used to time entry and exit points for swing trades. Combining RSI with other analysis techniques is recommended for better accuracy. Does RSI work on a 5-minute chart? Yes, RSI can be used on a 5-minute chart or any other time frame.
One technical indicator that can be used in conjunction with the RSI and helps confirm the validity of RSI indications is another widely-used momentum indicator, the moving average convergence divergence (MACD).
How to use RSI for scalping? ›
Scalp trading using the RSI
In the first example, the price is moving steadily higher, with the three moving averages broadly pointing higher. Dips in the trend are to be bought, so when the RSI drops to 30 and then moves above this line, a possible entry point is created.
Is RSI 50 buy or sell? ›
If the RSI is above 50, it indicates a bullish trend, while a reading below 50 indicates a bearish trend. By identifying the trend direction, traders can make better decisions on whether to buy or sell.
What is a good RSI number to buy? ›
The basic rule of thumb is that an RSI value over 70 indicates a stock is “overbought” and may see its price fall in the future. Meanwhile, an RSI value of 30 or lower can mean that the price could go up. An RSI of 50 is often seen as neutral, meaning the stock has not been either overbought or oversold.
What is the buying zone for RSI? ›
RSI the relative strength index is a non trending indicator. When the stock becomes oversold it crosses below 30 mark and moves back again above 30. Hence a stock can be bought above 30 mark.
What is the formula for RSI in Forex? ›
The calculation formula sequence involves these three straightforward steps: Choose a predetermined period “X” (Standard value is “14”, although a value of “8” or “9” tends to be more sensitive. Calculate “RS” = (Average of “X” periods up closes/Average of “X” periods down closes. RSI = 100 – [100/(1 + RS)].
How do you use RSI for trend trading? ›
50-crossover
Traders could use the RSI 50 level (the centreline) to confirm that a price trend is occurring. According to this strategy, a downward trend is confirmed when the RSI crosses from above 50 to below 50. Similarly, an upward trend is confirmed when the RSI crosses above 50.
What is the RSI 30 to 70? ›
The RSI is a technical indicator that measures the strength of a stock's price movement. A value between 30 and 70 is typically read as an indication that the stock is in a neutral momentum zone.
How do I buy and sell with RSI? ›
Low RSI levels, below 30, generate buy signals and indicate an oversold or undervalued condition. High RSI levels, above 70, generate sell signals and suggest that a security is overbought or overvalued.
