RSI (Relative Strength Index) Full Explain, By forex forum
The "Relative Strength Index", or "RSI", indicator is a popular member of the "Oscillator" family of technical indicators. J. Welles Wilder created the RSI in order to measure the relative changes that occur between higher and lower closing prices. Traders use the index to determine overbought and oversold conditions, valuable information when setting entry and exit levels in the forex market.
The Relative Strength Index (RSI) was developed by J. Welles Wilder, the author of another standard indicator for МТ4 and МТ5, the ATR indicator.
Wilder first published the description of the RSI indicator in Commodities magazine in 1978. A few years later, his book New Concepts in Technical Trading Systems was published, where he described the technical tool in more detail, using practical examples.
What does relative strength index mean?
According to the RSI definition, it is a momentum oscillator that measures the velocity and magnitude of price movements. It is a dynamic line moving in the scale from 0 to 100. The indicator compares the closing prices of the current and the previous candlesticks, indicating the trend strength.
How To Calculate & Use The RSI Indicator
What if there was a way to measure the strength of a move up or down using an indicator? Well the RSI is one of the most popular indicators of choice by traders around the world. The term 'Relative Strength Index' must not be confused with 'relative strength' which is when we compare one stock against another or one sector.
The RSI, like most indicators is the calculation of averages, this is what the calculation looks like.
Calculation
The average time period we use for the RSI is the 14 period average. Let's say in the last 14 days, there were 10 up days and 4 down days. We will take the average gain on the 10 days and divide it by 14 – then use the average loss of 4 days and divide it by 14. The RSI index assumes that bulls won on the day the stock closed green (closed up) and bearish when it closes down.
RSI Line Calculation
The default RSI setting is typically 14 period. Now let's dissect the RSI calculation a bit further:
First, let's take a look at the RSI formula taking the 14-period setting:
RSI = (100 – (100 / (1 + RS)))
RS stands for Relative Strength in the formula above.
This calculation looks pretty straightforward, but we also need to calculate the value of the Relative Strength (RS). This is how you calculate the RS variable:
RS = (14 EMA on the last 14 up bars) / (14 EMA on the last 14 down bars)
After you determine the value of the RS, you can apply the result in the first formula. This will give you the current RSI value.
RSI calculation
RSI = 100 – (100 / (1 + U/D))
Where:
U – average number of positive price changes
D – average number of negative price changes
Although 14 is the default, a number of settings are available which typically depends on the trading strategy employed:
- Short-term intraday traders (day trading) may favour lower settings using periods of 9-11.
- Medium-term swing traders tend to adopt the default setting of 14.
- Longer-term position traders normally prefer a higher period, ranging from 20-30.
Now, let us tell you about the key RSI-based strategies:
1. Wilder's strategy. According to it, one must buy an asset when the corresponding indicator rises higher than 30 and sell when it drops lower than 70. Thus, one must close a position, when there is a signal to open a deal in the opposite direction. As a result, one always has at least one position opened. But, there is a certain risk of technical flipping. To fix that, one can apply stop-loss and take-profit orders.
2. Connor's approach. It involves trading the major trend, but after adjusting entry conditions. Namely, one should buy an asset when RSI is in the oversold area and the price exceeds SMA (200). But a trader must also set the period at 2 (by default, it is 14) and signal levels at 10 and 90. For opening a sell order, one must catch a reverse situation. Experts advise applying this scheme for opening buy deals when the market is clearly growing or there is an obvious trend.
3. Watching divergences. Divergence is a situation when the real price differs from the data shown by the indicator. For example, if the price of the asset skyrockets up to the highest possible limits, but it is not reflected by the corresponding RSI indicator, that means the current market trend is rather weak and there is a risk of a reversal.
If you want to learn more about forex trading strategies then, you should join a forex forum. Inside a forex forum you will get more new and informative tips from forex experts.
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.
RSI Trade Entry
To enter a RSI trade, you need to see a signal from the RSI indicator. This could be either overbought or oversold RSI, or a RSI divergence pattern.
If you are entering on an overbought/oversold signal, then you would buy/sell the currency pair when the price action exits the respective threshold on the RSI indicator.
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