Using RSI in Forex trading is going to tell you if a stock is overbought or oversold. You can also use the RSI to confirm a trend; whether up or down. So just because the RSI has reached overbought or oversold level’s doesn’t mean the stock is going to reverse. That’s why you need confirmation from patterns, volume or other trading indicators.
What Is the RSI?
The Relative Strength Index (RSI) is an oscillator that measures the market momentum by comparing its upwards movement vs downwards movement over a specific time period. It was developed by a technical analyst named J.Welles Wilder. He described momentum as being the velocity of the directional price movement. So it’s not just whether the price is going up or down it’s how fast the price is moving up or down.
The RSI Forex indicator has been around since the 1970s and is a leading indicator. This means it provides an early signal on the price movement of an asset. Basically, the RSI measures the overbought and oversold conditions in the market.
When you plot RSI on a chart it oscillates a value between zero and a hundred. If the value of the RSI is below 30 it indicates an oversold market. And if it’s above 70 it indicates an overbought market. Besides that, RSI in Forex also gives an indication of the market direction.
For instance, if the RSI value is above 50, it signals that the market is trending up. Therefore, if it’s below the 50 it indicates that the market is trending down.
How to Use RSI in Forex
To trade using the RSI Forex indicator, the general is perception is that when the market is overbought it’s at the peak; and is likely to come down. So in simple words, you can sell when the RSI is above 70. And conversely, when it’s below 30 the market is likely to go back up so you can start buying.
To understand it further take a look at the EUR/USD chart below. The price had been rising and right when it touched the 1.1020 level the RSI was above 70. It showed an overbought zone. Following the RSI signal, the price reversed and dropped to almost 1.0780.
To understand the overbought signal take a look at the GBP/USD chart below. The pair had been falling from 1.2680 until at 1.2310 where the RSI was below 30 percent and gave an oversold indication. Following the oversold signal the price reversed and recovered to 1.2540.
The RSI Forex indicator can also be used to determine the exit level for your open positions. Let’s assume that you have a long position that’s in profit but you aren’t sure about the exit level. In this case, you can plot the RSI and if it’s above 50 you can continue to hold; but make sure to exit before it reaches the 70 level. Similarly, if you are short and RSI is below 50 you can continue to hold but exit just before it touches 30.
Just like any other technical indicator, the RSI Forex indicator can also produce false signals. To avoid trading false signals you can wait for a second confirmation by using additional indicators such as Moving Average, Bollinger Bands, and so forth.
Using the RSI Forex indicator can help you know when a reversal is coming; whether bullish or bearish. Just remember that it’s not 100% fool proof. So make sure to get confirmation and stick to your trading plan!