RSI Indicator Is a good Forex indicator to use in your real FX trading, J. Welles Widler, the originator of the concept Parabolic SAR also introduced the concept of RSI that is the abbreviated form Relative Strength Index. This concept is also descried in a book named “New Concept in the technical trading system”. The measurement of RSI is done on a 0-100 scale. If the reading of the scale is more than 70 then the market is overbought and if the reading is below 30 then the market is oversold. The figure below indicates the overbought and oversold areas on the chart.
How to use RSI indicator overbought and oversold areas on the chart
It is as simple as marking points on the chart. Open a chart and then go to Insert menu, click Indicators, click custom and select RSI. The tool will automatically draw RSI below in the chart. Now in RSI drawn, mark the points that value higher than 70 on the scale and this marked area is overbought area on the chart. In the figure above, points A and B are overbought. Now find the points that value less than 30 on the scale and mark the area. This marked area is oversold area in the chart.
Reading of RSI is between value 35-45 and 75-85 in the rising market and reading of RSI is between value 20-30 and 55-65 in the falling market. J. Welles Widler recommended setting a period of 14 days for analysis but now other time periods have also become popular. Traders and investors must follow some rules for making a long or short entry. For long entry, RSI (14) must move below 40 and move back above 30. MA (50) must be more than MA (200). For short entry, RSI must move above 70 and move back above 70. MA (50) must be less than MA (200).
Calculation of RSI is very easy. See the formula below.
RSI = 100 – (100 / (1 + U/D))
In the formula above,
U is the average of the positive price changes
D is the average of the negative price changes
The five uses of RSI are given below.
Indicate Tops and Bottoms
RSI is a good indicator to indicate top and bottom of any currency in the Forex market. Readings of RSI (14) above 70 are indicated as Top and the readings below 30 are indicated as bottom.
RSI may show charts that may not exist in real on the bar chart. You might observe a head or a shoulder formed on the RSI indicator that will not be seen on the bar chart.
A clear signal of reversal is given whenever the RSI reaches above 70 or goes below 30. The value of RSI outside the range of 30-70 shows that a reversal in market can take place any time.
Support and Resistance
Sometimes RSI indicator also show the support and resistance levels and these support and resistance levels can also be observed on the bar chart.
If the price of a currency touches a new low or high but if these new levels are not confirmed using the RSI then it is a very strong signal that a reversal of price is imminent and can happen anytime. See the figures below.
This indicator is very useful in determining if the market is overbought or oversold. Tops and Bottoms can be found using RSI indicator. RSI is also useful in predicting reversals.
How to draw RSI
Open a chart for any currency pair. Click on the Insert menu, click on the Indicator, click on the Custom and then click on the RSI.
Insert –>Indicators –>Custom –>RSI
After selecting the RSI as shown above, the RSI window opens as shown in the picture below.
Fill the values in this window as according to requirements and the RSI will be automatically drawn on your chart.