Uses Of The RSI Indicator In Forex Trading

Introduced in 1978 by Welles Wilder in his book “New Concepts in Technical Trading Systems,” the Relative Strength Index (RSI) oscillator is a Momentum indicator that measures the relative difference between closing prices of the higher and lower range. Thus, RSI = 100 – [100 / (1 + RS)]; where RS = Average of X day’s up closes / Average of X day’s down closes ( Average of N days up closes, divided by average of N days down closes), N = Predetermined number of days. This method indicates whether a market is oversold or overbought by measuring the internal strength of the forex market. The RSI clocks between 0 to 100.

The uses are:
Tops and Bottoms: A reading above 70 indicates an overbought market, meaning that it may be overvalued and should be considered for selling, while an oversold market, meaning that the market will likely become undervalued, is indicated by a reading below 30.

RSI & Chart Patterns: Within a chart, prices can be graphed by the RSI line and can be used to derive market predictions and warnings/cautions.

Top Failure Swings and Downside Failure Swings: When the RSI is above 70 or below 30, a failure swing occurs. It is generated when the price is unable to reach a new high when rising and new low when falling. In Top Failure Swings, an upward moving price is unable to reach and exceed a previous High over 70, followed by a downside break of a previous Low. In Downside failure swings, a downward price movement is unable to reach and exceed a previous Low below 30, followed by an upside break of a previous High.

RSI & Support & Resistance: Price Support & Resistance can be forecasted from the level displayed by the RSI line.

RSI & Divergence: The warning of a change in the market trend or market reversal is predicted when the difference between the RSI and the price (that is, when divergence occurs as the RSI is unable to follow the price in setting a new low or a new high) is above 70 or below 30. Divergence is a warning to exit or enter a trading position, and, therefore, RSI is one of the most important, simple and widely used indicators by market participants.

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