Relative Strength Index (RSI): You Want to Study It For These Buy or Sell Signals
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RSI Indicator Calculation & Formula
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Sometimes, overbought and oversold levels are set at 80 and 20 instead of 70 and This setting is used during increased market volatility. There are two ways to set up this indicator. Instrument configuration window will open before the indicator is set in the chart. This window allows you to configure the indicators parameters.
This parameter is set to 14 by default, and this setting is considered optimal in most cases. You can also adjust the style settings, like line colour and weight. By using another tab of configuration window, you can change parameters of the levels from 30 and 70 to 20 and You can also add new levels should your trading strategy require so.
The main signal the RSI oscillator generates allows defining overbought and oversold price ranges. Although it is frequently used as a filter in systems where the main indicator is a trend one, it might be possible to try trading using RSI signals only. However, trading using RSI signals only is not the best approach as it has been designed to be used as a filter and not the main instrument. A trading strategy will be more efficient when using a trend indicator or at least paying attention to the Price Action signals. The absence of trend indicators in this trading strategy is compensated by simultaneous analysis of two timeframes.
The only difference will be that instead of levels 30 and 70 we will set it at Stop Loss and Take Profit are fixed and set at distances 20 and 50 points from the opening price respectively. First, it is necessary to set up the following indicators in the trading chart :. All three signals should be received during three candles, otherwise, they will lose their value. Exiting an open trade should be done when RSI enters the opposite zone. Sometimes, an opposite position can be opened simultaneously with closing previous position, granting other signals to follow the above mentioned pattern.
For the moving averages, we will use the 4-period and period MAs. We will buy or sell the stock when we match an RSI overbought or oversold signal with a supportive crossover of the moving averages. We will hold the position until we get the opposite signal from one of the two indicators or divergence on the chart. Also, I want to clarify something about the MA cross exit signals.
A regular crossover from the moving average is not enough to exit a trade. I recommend waiting for a candle to close beyond both lines of the moving average cross before exiting the market. To illustrate this trading strategy, please have a look at the chart below:. RSI enters the oversold area with the bearish gap the morning of Aug Two hours later, the RSI line exits the oversold territory generating a buy signal.
An hour and a half later, the MA has a bullish cross, giving us a second long signal. Furthermore, this happens in the overbought area of the RSI. This is a very strong exit signal, and we immediately close our long trade. This is a clear example of how we can attain an extra signal from the RSI by using divergence as an exit signal. Now I will show you how to combine the relative strength index with the relative vigor index. In this setup, I will enter the market only when I have matching signals from both indicators.
I will hold the position until I get an opposite signal from one of the tools — pretty straightforward. First, we get an overbought signal from the RSI. Then the RSI line breaks to the downside, giving us the first short signal.
Two periods later, the RVI lines have a bearish cross. This is the second bearish signal we need and we short Facebook, at which point the stock begins to drop. After a slight counter move, the RVI lines have a bullish cross, which is highlighted in the second red circle and we close our short position. This trade generated a profit of 77 cents per share for a little over 2 hours of work.
Facebook then starts a new bearish move slightly after 2 pm on the 21 st. Unfortunately, the two indicators are not saying the same thing, so we stay out of the market. Later the RSI enters the oversold territory.
Using RSI in Forex Trading
A few periods later, the RSI generates a bullish signal. After two periods, the RVI lines also have a bullish cross, which is our second signal and we take a long position in Facebook.
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Just an hour later, the price starts to trend upwards. Notice that during the price increase, the RVI lines attempt a bearish crossover, which is represented with the two blue dots. Fortunately, these attempts are unsuccessful, and we stay with our long trade. Later the RVI finally has a bearish cross, and we close our trade. Here I will use the RSI overbought and oversold signal in combination with any price action indication, such as candlesticks, chart patterns , trend lines, channels, etc. To enter a trade, I will need an RSI signal plus a price action signal — candle pattern, chart pattern or breakout.
I will hold every trade until I get a contrary RSI signal or price movement that the move is over. The chart image starts with the RSI in overbought territory. After an uptrend, the BAC chart draws the famous three inside down candle pattern, which has a strong bearish potential. With the confirmation of the pattern, we see the RSI also breaking down through the overbought area. We match two bearish signals, and we short BAC.
The price starts a slight increase afterward. This puts us into a situation, where we wonder if we should close the trade or not. Fortunately, we spot a hanging man candle, which has a bearish context.
How Do You Use RSI in Forex Trading?
We hold our trade and the price drops again. Look at the three blue dots on the image. These simple dots are enough to build our downtrend line. After we entered the market on an RSI signal and a candle pattern, we now have an established bearish trend to follow! The trend resists the price yellow circle , and we see another drop in our favor. After this decrease, BAC breaks the bearish trend, which gives us an exit signal.
We close our position with BAC, and we collect our profit. This trade made us 20 cents per share. If you are new to trading, combining the RSI with another indicator like volume or moving averages is likely a great start. Pairing with the indicator will give you a set value to make a decision and removes a lot of the gray areas associated with trading. Once you progress in your trading career, you will want to look to methods using price action that are more subjective but being able to apply techniques specific to the security you are trading will increase your winning percentages over time.
The textbook picture of an oversold or overbought RSI reading will lead to a perfect turning point in the stock. This is what you will see on many sites and even earlier in this very post. As you see, there were multiple times that BFR gave oversold signals using the relative strength indicator. The stock continued higher for over three hours. Simple, you have to include a stop loss in your trade.
Get ready, because this will be a common theme as we continue to dissect how the RSI can fail you. The tricky thing about divergences is that the reading on the RSI is set by price action for that respective swing.