and introduced in his seminal book, New Concepts in Technical Trading Systems. The RSI can do more than point to overbought and oversold securities. It can also indicate securities that may be primed for a trend reversal or corrective pullback in price. It can signal when to buy and sell. Traditionally, an RSI reading of 70 or above indicates an overbought situation.

A reading of 30 or below indicates an oversold condition. As a momentum indicator, the relative strength index compares a security's strength on days when prices go up to its strength on days when prices go down. Relating the result of this comparison to price action can give traders an idea of how a security may perform. The RSI, used in conjunction with other technical indicators, can help traders make better-informed trading decisions.

The RSI uses a two-part calculation that starts with the following formula:. The average gain or loss used in this calculation is the average percentage gain or loss during a look-back period. The formula uses a positive value for the average loss. Periods with price losses are counted as zero in the calculations of average gain. Periods with price increases are counted as zero in the calculations of average loss.

The standard number of periods used to calculate the initial RSI value is The first calculation for the RSI would look like the following expanded calculation:. Once there are 14 periods of data available, the second calculation can be done. Its purpose is to smooth the results so that the RSI only nears or zero in a strongly trending market.

The RSI will rise as the number and size of up days increase. It will fall as the number and size of down days increase.

As you can see in the above chart, the RSI indicator can stay in the overbought region for extended periods while the stock is in an uptrend. The indicator may also remain in oversold territory for a long time when the stock is in a downtrend. This can be confusing for new analysts, but learning to use the indicator within the context of the prevailing trend will clarify these issues.

The primary trend of the security is important to know to properly understand RSI readings. For example, well-known market technician Constance Brown, CMT, proposed that an oversold reading by the RSI in an uptrend is probably much higher than Likewise, an overbought reading during a downtrend is much lower than As you can see in the following chart, during a downtrend, the RSI peaks near 50 rather than This could be seen by traders as more reliably signaling bearish conditions.

Many investors create a horizontal trendline between the levels of 30 and 70 when a strong trend is in place to better identify the overall trend and extremes. On the other hand, modifying overbought or oversold RSI levels when the price of a stock or asset is in a long-term horizontal channel or trading range rather than a strong upward or downward trend is usually unnecessary. The relative strength indicator is not as reliable in trending markets as it is in trading ranges.

In fact, most traders understand that the signals given by the RSI in strong upward or downward trends often can be false. A related concept focuses on trade signals and techniques that conform to the trend. In other words, using bullish signals primarily when the price is in a bullish trend and bearish signals primarily when a stock is in a bearish trend may help traders to avoid the false alarms that the RSI can generate in trending markets.

Generally, when the RSI indicator crosses 30 on the RSI chart, it is a bullish sign and when it crosses 70, it is a bearish sign.

Put another way, one can interpret that RSI values of 70 or above indicate that a security is becoming overbought or overvalued. It may be primed for a trend reversal or corrective price pullback.

An RSI reading of 30 or below indicates an oversold or undervalued condition. Overbought refers to a security that trades at a price level above its true or intrinsic value. That means that it's priced above where it should be, according to practitioners of either technical analysis or fundamental analysis.

Traders who see indications that a security is overbought may expect a price correction or trend reversal. Therefore, they may sell the security. The same idea applies to a security that technical indicators such as the relative strength index highlight as oversold. It can be seen as trading at a lower price than it should.

Traders watching for just such an indication might expect a price correction or trend reversal and buy the security. During trends, the RSI readings may fall into a band or range. During an uptrend, the RSI tends to stay above 30 and should frequently hit During a downtrend, it is rare to see the RSI exceed In fact, the indicator frequently hits 30 or below.

These guidelines can help traders determine trend strength and spot potential reversals. The opposite is true for a downtrend. If the downtrend is unable to reach 30 or below and then rallies above 70, that downtrend has weakened and could be reversing to the upside.

Trend lines and moving averages are helpful technical tools to include when using the RSI in this way. Be sure not to confuse RSI and relative strength. The first refers to changes in the the price momentum of one security. The second compares the price performance of two or more securities.

An RSI divergence occurs when price moves in the opposite direction of the RSI. In other words, a chart might display a change in momentum before a corresponding change in price.

A bullish divergence occurs when the RSI displays an oversold reading followed by a higher low that appears with lower lows in the price. This may indicate rising bullish momentum, and a break above oversold territory could be used to trigger a new long position. A bearish divergence occurs when the RSI creates an overbought reading followed by a lower high that appears with higher highs on the price. As you can see in the following chart, a bullish divergence was identified when the RSI formed higher lows as the price formed lower lows.

This was a valid signal, but divergences can be rare when a stock is in a stable long-term trend. Using flexible oversold or overbought readings will help identify more potential signals. An additional price-RSI relationship that traders look for is positive and negative RSI reversals.

A positive RSI reversal may take place once the RSI reaches a low that is lower than its previous low at the same time that a security's price reaches a low that is higher than its previous low price. Traders would consider this formation a bullish sign and a buy signal. Conversely, a negative RSI reversal may take place once the RSI reaches a high that is higher that its previous high at the same time that a security's price reaches a lower high. This formation would be a bearish sign and a sell signal.

Another trading technique examines RSI behavior when it is reemerging from overbought or oversold territory. This signal is called a bullish swing rejection and has four parts:. As you can see in the following chart, the RSI indicator was oversold, broke up through 30, and formed the rejection low that triggered the signal when it bounced higher.

Using the RSI in this way is very similar to drawing trend lines on a price chart. There is a bearish version of the swing rejection signal that is a mirror image of the bullish version. A bearish swing rejection also has four parts:. The following chart illustrates the bearish swing rejection signal. As with most trading techniques, this signal will be most reliable when it conforms to the prevailing long-term trend. Bearish signals during downward trends are less likely to generate false alarms.

The MACD is calculated by subtracting the period exponential moving average EMA from the period EMA. The result of that calculation is the MACD line. A nine-day EMA of the MACD, called the signal line, is then plotted on top of the MACD line. It can function as a trigger for buy and sell signals. Traders may buy the security when the MACD crosses above its signal line and sell, or short, the security when the MACD crosses below the signal line.

The RSI was designed to indicate whether a security is overbought or oversold in relation to recent price levels. It's calculated using average price gains and losses over a given period of time. The default time period is 14 periods, with values bounded from 0 to The MACD measures the relationship between two EMAs, while the RSI measures price change momentum in relation to recent price highs and lows.

These two indicators are often used together to provide analysts with a more complete technical picture of a market. The RSI line moves in and out of these three areas creating different signals on the chart.

The default RSI setting is typically 14 period. 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:. 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. It works the same time if you change the periods the RSI takes into consideration. If you change the settings to a period RSI, then the second formula will look like this:.

Then you add the result to the first formula for determining the RSI value. There are three basic signals provided by the Relative Strength Index technical indicator. Since it is a leading indicator, the signals can typically come prior to the actual price move happening on the chart, depending on what information you use to enter the trade. The first signal we will discuss is the overbought signal.

The RSI Indicator gives a signal for an overbought condition when the RSI line enters the area. The oversold RSI signal appears when the RSI line enters the area. When the RSI is oversold, it implies that the price is likely to increase. RSI Divergence is the last signal we will discuss. As with some other indicators, such as MACD and Stochastics, the Relative Strength Index Indicator can diverge from the overall price action which can provide clues into potential reversals in the market.

Bullish RSI Divergence — Price action is decreasing while the RSI line is increasing; this is a strong bullish signal on the chart. Bearish RSI Divergence — Price action is increasing, while the RSI line is decreasing; this is a strong bearish signal on the chart.

The RSI Indicator is built in many trading platforms including the most widely used forex trading platform — MetaTrader 4. The RSI tool then appears automatically at the bottom of your chart in its default period RSI setting.

RSI Analysis in Forex consists mainly of recognizing the signals described above. We will now illustrate each of the signals so you will get a better sense of how to analyze your chart using RSI. The image above shows how a RSI Overbought signal may appear. The RSI line breaks into the area first. This creates the overbought signal. The price then moves out of the overbought zone creating the actual sell signal on the chart. As you see, the price decreases afterwards.

And this is the Oversold RSI signal. The RSI line decreases and enters the area creating the signal. The buy indication appears when the RSI line breaks the oversold zone upwards and enters the neutral zone between 30 and As you see, the price action increases afterwards. This time we will describe the bullish RSI divergence. The blue line on the price chart indicates that the price action is creating lower bottoms, while the RSI line is increasing.

This shows that there is a bullish divergence between the price action and the RSI indicator, meaning that the price of this pair is likely due for an increase. As you can see, this is exactly what happens. The bearish divergence acts the same way, but in the opposite direction — price action tops are increasing and the RSI tops are decreasing. We will now switch gears and discuss some strategy building ideas with the RSI indicator. We will use the signals described above to set entry and exit points on the chart using the basic RSI rules.

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 trading a divergence with the RSI indicator, then you would enter a trade in the direction of the RSI, after the price action closes two or three candles in a row in the direction of your intended trade.

As we mentioned earlier, the RSI indicator can give many false or premature signals if used as a standalone tool. Even when combining it with other confirming studies, it is necessary to use a stop loss to protect losses on our trade. The optimal place for your stop loss order is beyond a recent swing top or bottom, created at the time of the reversal you are trading.

The basic RSI rule states that you should hold your trade until getting an opposite signal from the RSI indicator. Again, this could be an overbought or oversold signal, as well as bullish or bearish RSI divergence. But in the practical sense, it makes sense to take your partial or full profits out earlier using other price action based rules or a trailing stop loss. Let take a look at how a basic RSI trading strategy with the rules we discussed earlier could work.

The image shows you a trade entry and exit based solely on signals coming from the Relative Strength Index indicator.

The RSI indicator is a technical trading tool that falls within the oscillator family. The RSI indicator is considered a leading indicator, which means that its signals typically come prior to a price event on the chart. The positive side of this is that we are able to attain early signals for our trades, but the downside is that many of these signals can be false or premature.

Therefore, the RSI should always be used in a combination with another Forex trading tool or technique for confirmation.

In this lesson, we will dissect the RSI indictor and give some best practices for trading with it. The RSI indicator was developed by an American mechanical engineer named J.

Welles Wilder. The indicator usually attaches to the bottom of your chart in a separated horizontal window. The Relative Strength Index technical indicator consists of a single line, which fluctuates between area. The area is separated based on three primary zones:. The RSI line moves in and out of these three areas creating different signals on the chart. The default RSI setting is typically 14 period. 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:. 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. It works the same time if you change the periods the RSI takes into consideration. If you change the settings to a period RSI, then the second formula will look like this:. Then you add the result to the first formula for determining the RSI value.

There are three basic signals provided by the Relative Strength Index technical indicator. Since it is a leading indicator, the signals can typically come prior to the actual price move happening on the chart, depending on what information you use to enter the trade.

The first signal we will discuss is the overbought signal. The RSI Indicator gives a signal for an overbought condition when the RSI line enters the area. The oversold RSI signal appears when the RSI line enters the area.

When the RSI is oversold, it implies that the price is likely to increase. RSI Divergence is the last signal we will discuss. As with some other indicators, such as MACD and Stochastics, the Relative Strength Index Indicator can diverge from the overall price action which can provide clues into potential reversals in the market. Bullish RSI Divergence — Price action is decreasing while the RSI line is increasing; this is a strong bullish signal on the chart.

Bearish RSI Divergence — Price action is increasing, while the RSI line is decreasing; this is a strong bearish signal on the chart. The RSI Indicator is built in many trading platforms including the most widely used forex trading platform — MetaTrader 4.

The RSI tool then appears automatically at the bottom of your chart in its default period RSI setting. RSI Analysis in Forex consists mainly of recognizing the signals described above.

We will now illustrate each of the signals so you will get a better sense of how to analyze your chart using RSI. The image above shows how a RSI Overbought signal may appear. The RSI line breaks into the area first. This creates the overbought signal. The price then moves out of the overbought zone creating the actual sell signal on the chart.

As you see, the price decreases afterwards. And this is the Oversold RSI signal. The RSI line decreases and enters the area creating the signal. The buy indication appears when the RSI line breaks the oversold zone upwards and enters the neutral zone between 30 and As you see, the price action increases afterwards.

This time we will describe the bullish RSI divergence. The blue line on the price chart indicates that the price action is creating lower bottoms, while the RSI line is increasing. This shows that there is a bullish divergence between the price action and the RSI indicator, meaning that the price of this pair is likely due for an increase.

As you can see, this is exactly what happens. The bearish divergence acts the same way, but in the opposite direction — price action tops are increasing and the RSI tops are decreasing. We will now switch gears and discuss some strategy building ideas with the RSI indicator. We will use the signals described above to set entry and exit points on the chart using the basic RSI rules.

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 trading a divergence with the RSI indicator, then you would enter a trade in the direction of the RSI, after the price action closes two or three candles in a row in the direction of your intended trade.

As we mentioned earlier, the RSI indicator can give many false or premature signals if used as a standalone tool. Even when combining it with other confirming studies, it is necessary to use a stop loss to protect losses on our trade. The optimal place for your stop loss order is beyond a recent swing top or bottom, created at the time of the reversal you are trading.

The basic RSI rule states that you should hold your trade until getting an opposite signal from the RSI indicator. Again, this could be an overbought or oversold signal, as well as bullish or bearish RSI divergence. But in the practical sense, it makes sense to take your partial or full profits out earlier using other price action based rules or a trailing stop loss.

Let take a look at how a basic RSI trading strategy with the rules we discussed earlier could work. The image shows you a trade entry and exit based solely on signals coming from the Relative Strength Index indicator. The chart starts with a price decrease which is also confirmed by the bearish direction of the RSI line. Suddenly, the RSI line enters the area, creating an oversold signal.

Shortly afterwards, the RSI line starts increasing, while the price action continues its downward movement. This creates a bullish divergence between the price action and the Relative Strength Index. Your first thought might be that you should open a long trade at the moment when the RSI line breaks the oversold zone upwards. However, during this time, you identify the bullish divergence, meaning that it might be better to wait for two or three bullish candles in a row as the actual entry signal.

You should place a stop loss order right below the bottom created at the moment of the reversal. This is shown with the red horizontal line on the chart.

The price action increases afterwards and enters a bullish trend. The RSI line increases as well. The trade could be held at least until the RSI indicator reaches the 50 mark, at which point you could close a portion of your position.

Alternatively, you could decide to use some other price action clues that provide sufficient evidence to close the trade.

But absent that, it would be wise to exit the trade in full when RSI reaches the overbought threshold of The red circle on the chart shows the moment when the RSI indicator enters the overbought area, creating a close signal. Using the RSI indicator in isolation will not likely create a profitable trading strategy over the long run. As with most other leading indicators, the Relative Strength Index can be prone to giving false signals.

Therefore, you should incorporate an approach that will allow you to isolate as many false signals as possible, increasing your Win-Loss ratio. In this next section, we will discuss some of the way you can use the RSI tool in combination with price action to increase your chances of a winning trade. You would look to open your trade when you find a RSI signal confirming the direction. However, you will also confirm the price direction with a price action pattern.

This could be a candlestick pattern or a chart pattern, as well as a trend line, channel, ascending or descending tops and bottoms, etc. The stop loss order should be positioned according to the basic RSI rules we discussed above. When you identify the turning point on the chart, you should place your stop above that most recent swing. When you see, an opposite signal coming from the RSI, you should close your trade on the assumption that the price action is likely to reverse.

However, if you spot a price action clue that provides evidence for the end of the price move, you should also take that into consideration for closing the trade. The image illustrates 5 trade setups based on RSI signals combined with price action. The price enters a consolidation afterwards creating the blue triangle on the chart. The triangle breaks through the lower level creating an exit signal.

A closing signal appears when the RSI line enters the overbought area. The stop loss of the trade should be positioned above the top of the Expanding Triangle.

The position should be closed when the RSI line enters the oversold area. The stop loss on the trade should be positioned below the bottom of the Expanding Triangle. You could exit the trade when the RSI enters the overbought area. Then you should place a stop loss order above the top of the range. Your trade should be closed when the RSI enters the oversold area.

Take Your Trading to the Next Level, Accelerate Your Learning Curve with my Free Forex Training Program. Home Trading Articles Forex Futures Crypto Stocks Options. Download the short printable PDF version summarizing the key points of this lesson….

With practice, and in combination with a firm understanding of volume and price action, the RSI indicator can simply be a helpful tool in your trading arsenal. Welles Wilder in the 70s. This is the commonest of ways to trade forex for individual traders. If you are using MetaTrader MT4 , you can attach the indicator on your MT4 chart, and simply drag and drop it to the main chart window. Using the RSI in this way is very similar to drawing trend lines on a price chart. It is the best technical tool, and you should surely use it because it also involves price action and formula-based indicators. When you see, an opposite signal coming from the RSI, you should close your trade on the assumption that the price action is likely to reverse.

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