RSI (Relative Strength Index) for Technical Analysis in Forex Trading:
RSI was developed by J. Welles Wilder
RSI is one of the commonly used momentum indicators (oscillator) for technical analysis in Forex Trading. The signals given by RSI are as follows:
1) When a currency pair is overbought:
suggesting that its time to short sell.
2) When a currency pair is oversold:
suggesting that its time to buy.
Please not that RSI (relative strength index) works well when the currency pair prices move in range but gives false signals when the market is in trend i.e. Bullish (uptrend) or Bearish (downtrend). You may use ADX for analyzing if the market is in range or has a trend.
RSI readings range from 0 to 100.
When the RSI nears 30 or goes below 30, the signal is that the currency pair is oversold and it may be the time to buy the pair.
When RSI nears or crosses 70 and goes below, the signal is that the market is overbought and it may be the time to short sell the currency pair..
In the above Forex chart for EUR/USD at points A, B, C, D and E the RSI is either close to 70 or over 70. Points B, C, D, E (at the bottom of the chart) are when the market is running in the range (sideways). By range we mean that there is no up or down trend.
The yellow vertical lines are connecting these RSI levels to the prices on the candle-stick Forex chart for EUR/USD above.
If you see the corresponding points A, B, C, D, E on the candle-stick chart (top) you will see that the prices are going down after touching these points. So if would have we short-sold the currency pair when the prices were at A, B, C, D or E, it would have generated profits as the prices went down subsequently.
Similarly the points X, Y (at the bottom) are where the RSI was either nearing level 30 or had gone below the level 30.
The red vertical lines are connecting these RSI levels to the prices on the candle-stick chart above.
If you notice the corresponding points X and Y on the candle-stick chart (top) you would see that the prices bounced back subsequently i.e. gone up after touching these points (points X & Y). So if we bought when the prices were at X or Y, we would have ended with profits as the prices went up afterwards.
Checking ADX to see if market is moving sideways (ADX below 25) and using RSI:
RSI is good when market in range (neither bullish nor bearish but moving sideways in a range) but not when its trending market (uptrend i.e. bullish or downtrend i.e. bearish)
Cautious approach:
Buy the currency pair when RSI goes up the 30 mark, take a small dip again and come over 30 again below 30 (as small correction) and comes back up little over 30. Take profit when the prices go up.
Sell the currency pair when RSI goes below 70 mark. Takes a correction to go up again and then comes below 70 again.
Buying and selling the currency pair at the first crossover/signal is never advisable and we should wait for a correction and reconfirmation.
It is possible that when the RSI is going up, it does not cross or touch the level 70 but starts going down from a level below 70 e.g. from lets say after it reaches the level 65.
Similarly It is possible that when the RSI is going down, it does not cross or touch the level 30 but starts going up from a level above 30 e.g. from lets say after it reaches the level 35.
In such cases we might miss the chance of entering market and if you are ready to take more risk then you can enter the market just below 70 (short-selling), when RSI is going up or just above RSI 30 (buying), when RSI is going down.
Period setting in technical analysis indicators :
In Forex trading the quite preferred setting for the RSI is 14 periods, which means if we were to calculate RSI on a daily forex chart we would measure 14 days, and in the case of an hourly forex chart, we would measure 14 hours. The default setting of 14 is common to several popular indicators, such as Relative Strength Index (RSI) and Average True Range (ATR).
We explained RSI (Relative Strength Index) in the context of Forex Trading but the same stands good for stock trading or any commodity trading.
