The Relative Strength Indicator (RSI) is used to help identify whether the price of an asset has been either overbought through a sustained move to the upside or oversold to the downside. When price moves to one of these extremes, a reversal can typically be expected at some point. The RSI can indicate to traders and investors to buy when the currency is oversold and sell when it is overbought as part of their trading strategy.
MEASURING MARKET TREND STRENGTH
The difficulty is in identifying when a reversal is taking place in order to evaluate the potential trading opportunity. The RSI is an oscillating indicator that measures the relative velocity and magnitude of recent changes in price direction. It essentially measures the momentum - that is, the rate at which price has risen or fallen.
RSI oscillates between 0 to 100 and is charted as a line across a default trading time frame of 14 days for comparing up to down trading periods.
A reading of 30 or under is considered oversold and identifies a potential rate increase.
A reading of 70 or higher is considered overbought and identifies a potential rate decrease.
A movement from below the centerline to above is seen as a rising trend.
A crossover from above the centerline to below, indicates a falling trend.
Today's trading platforms are capable of performing the RSI calculation automatically, so it is not necessary for you to do this manually. However, it is helpful for you to understand how the RSI is determined starting with the actual RSI formula:
RSI = 100 - [100 / (1 + RS)] — Where: RS (Relative Strength) = average gain / average loss
RSI oscillating between overbought market conditions and oversold market conditions. The RSI indicates momentum by providing a relative evaluation of the strength of an asset’s recent price performance. The RSI level is a measure of the asset’s recent trading strength. The RSI’s slope is directly proportional to the velocity of a change, while the distance traveled is proportional to the magnitude of the move.
READING RSI SIGNALS
The RSI indicates momentum by providing a relative evaluation of the strength of an asset’s recent price performance. The RSI level is a measure of the asset’s recent trading strength. The RSI’s slope is directly proportional to the velocity of a change, while the distance traveled is proportional to the magnitude of the move.
According to Wilder, an RSI value falling within the 0 to 30 region is considered oversold. Some traders assume that an oversold currency pair is an indication that the falling market trend is likely to reverse, thus an opportunity to buy (i.e. a bullish signal).
On the other hand, an RSI value falling into the 70 - 100 region of the scale, is regarded as being overbought. This signal suggests that the resistance level for the currency pair is near or has been reached and the rate is likely to fall. Some traders would interpret this as a sell opportunity (i.e. a bearish signal).
CONFIRMING RSI SIGNALS
Because sudden, major movements can create false signals, RSI is sometimes best used alongside other technical indicators that can help confirm the perceived trend. It is often used together with trend lines, which can coincide with RSI support or resistance levels. Another method for refining RSI’s application is to track divergence between the indicator and price. This happens when an asset hits a new high or low in price, but the RSI does not follow suit in value terms. When price makes a new high, but the RSI does not, it is usually interpreted as bearish divergence and is interpreted as a signal to sell. When price makes a new low without this being followed suit by the RSI, it is usually read as a bullish buy signal.
The RSI is a smoothed oscillator, so it will not reflect price movements in the way that, for example, MACD studies might. It’s important to remember that RSI will often provide signals before the information is reflected on the price chart.
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A trading strategy can offer benefits such as consistency of positive outcomes, and error minimization. An optimal trading strategy reflects the trader’s objective and personal approach.
Fundamental traders watch interest rates, employment reports, and other economic indicators trying to forecast market trends.
Technical analysts track historical prices, and traded volumes in an attempt to identify market trends. They rely on graphs and charts to plot this information and identify repeating patterns as a means to signal future buy and sell opportunities.
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This page is for general information purposes only: examples are not investment advice or an inducement to trade. Past history is not an indication of future performance.
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