This technical indicator is one of the most used in Forex strategies. I will explain below how you can better read the movements that the indicator makes to make better decisions.
What is the RSI indicator?
The Relative Strength Index (RSI) is a well-know oscillator used in technical analysis and multiple markets, including Forex, which shows the price momentum by comparing bullish and bearish movements of closing prices of a specific asset.
The RSI oscillates between “0” and “100” levels but for trading purposes are used as reference 3 levels in which the following is highlighted:
- Level 70: indicates that the market is in an overbought condition.
- Level 50: is the “trigger” or signal
- Level 30: Indicates that the market is in an oversold condition
This indicator has the following functions:
- It shows price divergences.
- It allows predicting possible trend line breakouts in the price.
- It helps validate the chartist analysis.
- It allows confirming market entries (trading signals).
- It helps to forecast the overbought and oversold conditions in the price.
- It works in any timeframe.
- It works practically on any financial instrument.
The RSI, in addition to showing oversold or overbought levels, as well as buying and selling signals, may also show divergences between indicator and price. Divergences can be bullish (buy signal) and bearish (sell signal).
This type of signal has high reliability but must be supported by other technical analysis tools to decide to enter the market.
The RSI-price divergence represents a potential entry signal into the market in the opposite direction concerning the original price trend, be it bearish or bullish.
Here is an example of a Bullish Divergence:
It occurs when the price lows are getting lower and the equivalent lows of the RSI are increasing. In other words, the price falls as the RSI rises.
Bearish Divergence: It occurs when the price Highs are getting higher and the equivalent highs of the RSI are decreasing. In other words, the price rises as the RSI falls.
The RSI and Trend Line Breakouts
The RSI can also indicate the possibility of trend line breakouts. For this, simply add a trend line to the maximum or minimum points in the price corresponding to the support points for a trend line and when there is a breakout in the RSI, then this breakout may be followed by a breakout in the trend line
This signal is reliable but must be accompanied by more technical analysis tools.
Charts Analysis Patterns confirmation with RSI
The RSI among its other functions allows us to confirm some chart patterns and this greatly increases the reliability of chartist analysis.
In the following example, we see a classic trend continuation pattern whose name is flag which usually appears in upward or downward trends.
When you find other chart patterns in the price as triangles you can use the RSI to identically identify such formation.