Many popular trading platforms offer built-in automatically calculated indicators.
Of the various indicators available on the market, one of the most commonly used is the Relative Strength Index (RSI) indicator.
The RSI indicator
The RSI indicator is one of the few indicators that stood the test of time. It has been a prominent momentum oscillator throughout the years. The RSI calculates the momentum as a ratio between the highest closing prices and the lowest closing prices over a selected time.
This means that having a downtrend momentum would mean lower readings and vice versa. The RSI indicator evaluates through a scale from 0 to 100 with the Exponential Moving Average (EMA), and the high and low levels denoted.
Parts and patterns
In most oscillators, the centerline bears no meaning other than denoting the middle range on a chart. However, this line is useful for the RSI indicator. It helps discern early shifts in the underlying price trend, known as the candlestick. Having readings above the centerline could mean a bullish trend. Alternatively, it could indicate a bearish trend.
Patterns are also of importance when it comes to trading with the RSI indicator. EMA can formulate these patterns, and they can be used to predict future price action. Some technical patterns to watch out for include support and resistance, double tops and bottoms, and the trend line.
The typical period to compute the RSI indicator is 14 periods. This means that it examines the closing price of 14 candles for one reading in the timeframe used. However, brokers have adapted this to better suit their trading strategies.
While trading platforms typically do the math for you, the RSI indicator’s formula is fairly simple: the average gain is divided by the loss within the timeframe.
RSI = average gain in the period/loss in the period.
RSI = 100 – (100 / [1 + RS]).
Compute for the average gain by adding the product of the previous average gain, the periods that have passed, and the current gain. Then, divide the sum by the period of the trade excluding the first day.
Using the RSI to gauge conditions
The RSI can indicate whether a currency is being overbought or oversold. An RSI above 70 means that an asset is overbought while an RSI below 30 means an asset is oversold. The RSI can remain in either state for long periods, so cautious traders often prefer to use 80 as an indicator of overbuying and 20 for overselling.
Mathematically, RSI does measure strength. However, trading based only on RSI is flawed because there’s much prediction that goes into trading due to the market’s uncertainties.
You would benefit from combining RSI with other tools, especially indicators that complement RSI. Some of these tools are other indicators like EMA and MACD.
Make sure to depend on your Forex trading style to better determine the extent of the risks. Trading based solely on indicators isn’t perfect, but trading without them would be foolish. If used correctly, the RSI indicator could make a profit for you.
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