How to Use RSI (Relative Strength Index) in Forex Trade

 

How to Use RSI (Relative Strength Index)

Relative Strength Index (RSI)

The RSI indicator is a technical indicator and is plotted on a chart that ranges from 0 to 100. This helps a trader know the relative strength of trend formations. The indicator is an oscillator that provides overbought or oversold signals based on the position of the line on the chart. During an uptrend, if the line crosses the 70 mark, an overbought signal is considered for the given security. Symmetrically, during a downtrend, if the line crosses the 30 mark, an oversold signal is considered. Momentum traders typically take positions in the index without waiting for a price change when the line crosses a given threshold. For example, a trader can use the halfway mark of 50 to get an idea of a trend formation. If the RSI line crosses the 50 mark and moves in an upward direction, it may indicate high strength of the upward trend and the trader may take a long position in the respective stock.

Relative Strength Index, or RSI, is a popular indicator developed by a technical analyst named J. Welles Wilder, that helps traders evaluate the strength of the current market.

RSI is similar to Stochastic in that it identifies overbought and oversold conditions in the market.

Some traders interpret that an overbought currency pair is an indication that the rising trend is likely to reverse, which means it’s an opportunity to sell.

In addition to the overbought and oversold indicators mentioned above, traders who use the Relative Strength Index (RSI) indicator also look for centerline crossovers. 

A movement from below the centerline (50) to above indicates a rising trend.

A rising centerline crossover occurs when the RSI value crosses ABOVE the 50 line on the scale, moving towards the 70 line. This indicates the market trend is increasing in strength, and is seen as a bullish signal until the RSI approaches the 70 line.

A movement from above the centerline (50) to below indicates a falling trend.

A falling centerline crossover occurs when the RSI value crosses BELOW the 50 line on the scale, moving towards the 30 line. This indicates the market trend is weakening in strength, and is seen as a bearish signal until the RSI approaches the 30 line.

How to Trade Using RSI

RSI can be used just like the Stochastic indicator.

We can use it to pick potential tops and bottoms depending on whether the market is overbought or oversold.

Below is a 4-hour chart of EUR/USD.

EUR/USD had been dropping the week, falling about 400 pips over the course of two weeks.

On June 7, it was already trading below the 1.2000 handle.

However, RSI dropped below 30, signaling that there might be no more sellers left in the market and that the move could be over.

Price then reversed and headed back up over the next couple of weeks.

Determining the Trend using RSI

RSI is a very popular tool because it can also be used to confirm trend formations.

If you think a trend is forming, take a quick look at the RSI and look at whether it is above or below 50.

If you are looking at a possible UPTREND, then make sure the RSI is above 50.

If you are looking at a possible DOWNTREND, then make sure the RSI is below 50

At the beginning of the chart above, we can see that a possible downtrend was forming.

To avoid fakeouts, we can wait for RSI to cross below 50 to confirm our trend.

Sure enough, as RSI passes below 50, it is a good confirmation that a downtrend has actually formed.