In this post I will cover the the proper using of rsi (relative strength index) oscillator and how anybody can use it in couple of ways to get more accurate trading signals.
It has been developed since the late 70s. So it’s probably one of the most using oscillators allover the world. It is quite simple and I’m all in favor of keeping things simple, but there are many ways you can use it to gather more potential trading oportunity. So first of all, before looking at how it works in the real chart, let’s
just know the formula and how this is actually calculated. For those of you who are good at maths, here is the calculation of the RSI. The RSI is 100 minus 100 over 1 minus R so what is the RSI in this calculation? let me explain,This is really at the core of the RSI. RSI is the average of X number of days up divided by the average of X number of days down. So to keep it in simple language let’s say we’re using a 10 day’s RSI.So, it gathers information of the last 10 days and how many days did the market finish up and it adds the total points gained on those up days and divides it by 10.After that we have an average of the points gained when the market was up and of course the inverse supply should down here. If the last 10 days the market stayed down for the number of points lost in those four days are added up and
divided by ten and we end up with an accurate average point of value .Once it is setup on the chart we always have a value between 0 and a 100 percent. So this is the formula for the RSI. You don’t need to memorize it . Charting software will just generate this and put it on the chart automatically. But first of all how it works in a real chart on an actual trading market? looking at just the overbought oversold signals and how good or how bad they might have been .Let’s start with a simple and clean chart.
we’ve got pound u.s. dollar 0 spread daily candlestick chart and each candle describe all the data of a day’s worth of trading nothing else. On the chart let’s add our RSI. Now, we need to find the RSI from the indicators tab after that we have to click down.we can choose oscillators and scroll
down a little bit and click on relative strength index. It is in the most popular area because it is one of the most popular indicators of all time and of course it is widely used.
Next ,click on manage strength index – It defaults setting is 14-day RSI. I like a 10-day RSI because it is two weeks we can modify.The overbought and oversold areas ,lets stick with the default 70% and 30% click on confirm and the RSI gets setup on our chart .On the RSI we always have a value between 0 and a 100 percent. Anything above 70 percent area
here the market is said to be overbought and anything below 30 percent here the market is said to be over sold.When the RSI goes into overbought it is saying that maybe the strength has gone
too far away and if we get back to some of the the oversold areas,it would be probably one of the best
indication that maybe the market has gone down too far and for a bounce
back it is not perfect like all of these
indicators. I am saying perfect but it gives us a way of taking the temperature of the market now. if I change this to an one hour chart my RSI is still there. Of course but now rather than looking at the last ten days it’s looking at the last ten hours of price so we have a much messy RSI . Obviously if you change the timeframe of the chart you’re going to get different signals because you’re looking for a different price data. let’s go back to a One day chart for now.So at the moment the RSI was pretty much in themiddle between 0 and 100%.
trading around the 55 percent is ok, but it’s at the extremes if we’re using overbought oversold whereeverybody will be looking for the RSI to get there and confirm. Maybe what they are reading of the chart or the news or the fundamentals or any market moving factor is telling them for looking to sell when the RSI touch the area of overbought and then looking to buy when it goes or dips into oversold is one of the greatest strategies.Because,markets do move around obviously you do get a few overbought oversold signals and they’re maybe not as trustworthy as another way of using the RSI. Lets looking at the idea of price divergence. don’t forget the RSI is just a calculation and purely math based on what the market has been doing and remember it is not some magic formulas .
What is rsi divergence?
A divergence occurs when the price and the occilator like rsi , macd can not agree the price. Let say that price is making higher high but the rsi is making lower low. Boom! The divergence has been made.Now what to do,, well, when divergence happens , actually it is saying that be ready a reversal is coming. When you spot a price divergence stop trading with current direction. There is another types of divergence called hidden divergence. You can google it for more information. In this post I have talked about regular divergence only.With is you will be able to only find regular reversal point. Catching reversal is not a big deal if you can properly use the concept of price divergence. Remember in forex market there is no overbought or oversold . You can only use this concept with stock market.
You can use any oscillator and you will be able to spot it with an open eye.
Good luck and happy trading.