RELATIVE STRENGTH INDEX (RSI)

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.

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.

OVERSOLD INDICATOR

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).

OVERBOUGHT INDICATOR

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.