Relative Strength Index RSI

By: Monica Hendrix
The Relative Strength Index RSI is a popular and powerful technical analysis oscillator which has numerous applications including:

Indicating the strength of a price trend and also generating buy and signals with price divergences. The Relative strength Index is quite simply one of the best indicators to use with your forex charts so let’s look at it.

Background

The RSI, as its name implies measures the relative strength of price currently compared to its past price. The RSI was developed by J.Welles Wilder and was outlined in his classic book "New Concepts in Technical Trading Systems" published in 1978.

The RSI does not show just the markets strength - but the strength compared to the markets former price history.

The RSI is calculated as follows:

Do not worry if you don’t understand the mathematics, this indicator is very visual and you can simply watch the set ups – you don’t need to know how an internal combustion engine works to drive a car and it’s the same with the RSI.

For those who like math’s here is the calculation:

Within a set period of days - the individual difference between the upward closing prices (Close today Close previous day) are added together - the number is then divided by the number of observations in the period chosen minus one.



The end result is the day’s mean value of the upward and downward strength of the market which is then displayed visually.

Keep In Mind

The shorter the Period of time used for the RSI calculation, the more volatile the RSI will be. The RSI indicator has a default of 14, which is the value Wilder originally used when he calculated it. Other values have become popular and include 9, 11, and 25 day periods.

Using the RSI

1. Divergence of Price and RSI

Say the market makes new highs on the chart but the RSI fails to get above its previous high – this would indicate that the trend is starting to falter and is running out of momentum.

Here Traders would be alert for trading signals to enter contrary to the current trend.

2. As an Overbought / Oversold Indicator

The RSI measures the market’s strength and weakness as we have already seen and works very well as an overbought oversold indicator on forex charts.

An RSI, above 70, indicates an overbought bull market and an RSI below 30 indicates and oversold bear market.

When these levels are reached, traders would be looking for a price break and to execute trading signals in the opposite direction.

Combining RSI Other Indicators

By indicating the strength or weakness of price the Relative Strength Index acts as a leading indicator, to alert you to changes in the trend.

The RSI can be used by long term trend followers or swing traders and is simple and easy to use.

Like all indicators it doesn’t work all the time.

To confirm trading signals, it should be used with other momentum indicators and perhaps the best is the stochastic - to actually trigger the signals, once the set up has been spotted on your charts.

The Relative Strength index is now nearly 30 years old - but just like the other indicator Wilder outlined in his book (Average Directional Movement ADX) its a timeless indicator, which will enhance any Forex trading strategy.

Try using it with your forex charts, combined with the stochastic indicator and you will trade with greater accuracy, great profit potential and enjoy greater currency trading success.

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