Forex, Forex Analysis, Forex strategy

FX indicators: what is the RSI?

A forex indicator is a statistical tool that currency traders use to judge the direction of a currency pair’s price action. Indicators are either leading or lagging indicators, depending on what stage of the trend they are most useful for. There are many different forex indicators, each with its strengths and weaknesses.

RSI explained

The Relative Strength Index (RSI) is a financial market technical indicator that may be used to evaluate markets. It analyzes recent price changes to determine whether a security or market is oversold or overbought. It assesses the speed and degree of price change and is a numerical value between 0 and 100 that indicates the current strength of a stock or currency. A reading above 70 indicates overbought territory, and below 30 indicates oversold territory.

Always remember that the RSI is a lagging indicator, thus they cannot predict future price changes using it. Instead, it should be used as part of a broader trading strategy.

A lagging indicator

A lagging indicator is an indicator that gives a signal after a particular event has happened. You can use it to confirm trends but not predict them. Common examples of lagging indicators include moving averages and the Relative Strength Index (RSI). Lagging indicators are often used in conjunction with other indicators, such as leading indicators, to give traders a complete picture of the market.

How is the RSI calculated?

The Relative Strength Index (RSI) is the average of up closes and down closes, divided by the total number of periods.

To get the average down close, add all down closes for the given period and divide by the total number of periods. Finally, divide the average by the average close to arrive at the RSI.

One of the most important things you need when it comes to trading is to identify potential trading setups. It is where using indicators like the Relative Strength Index (RSI) can be extremely helpful.

Calculating RSI

The RSI is calculated using a simple formula:
RSI = 100 – (100 / (1 + RS))

Where:

RS = Average Gain / Average Loss

The RSI is a bounded oscillator that ranges between 0 and 100. readings below 30 are considered to be overextended, while readings above 70 are regarded as being overbought.

RSI setup

Look for divergences to profit from the RSI. When the price of a security makes new highs (or lows), but the RSI is not, this is an indication that a reversal in trend may be on the way.

Another way to use the RSI is to look for trendlines. When the RSI breaks above (or below) a trendline, it can indicate that the current trend is about to change.

How to use the RSI in FX?

There are many different ways the RSI can be used in forex trading. Some common strategies include using the RSI to identify overbought and oversold conditions and divergences between the RSI and price.

Overbought and oversold conditions:

The RSI can be used to identify potential reversals in the market. An overbought reading (above 70) suggests that the market is becoming overheated and may be due for a correction. An oversold reading (below 30) suggests that the market is becoming oversold and may be due for a rebound.

Divergences

A divergence occurs when the RSI moves in a direction opposite to price. It’s an excellent way to identify a possible reversal signal. For example, if the price is making new highs, but the RSI is failing to reach new highs, a bearish divergence suggests the price may soon start to fall.

Advantages

One of the main advantages of the RSI is that it is a versatile indicator that they can use in various ways. It is also relatively easy to interpret, making it a good choice for beginners. However, it is essential to remember that the RSI is a lagging indicator, so it should be used as part of a broader trading strategy.