RSI indicator (Relative Strength Index) is one of the main oscillators used in technical analysis. This instrument helps to assess pricing dynamics against the previous values.
RSI offers a chance to define the market sentiment and spot the points at which the market is overbought and oversold.
It is also used to detect times when the price is about to reverse, and a new trend rises.
Table of Contents
- What is the RSI indicator?
- How to set up and adjust the RSI indicator?
- How to trade with RSI?
- Using RSI with additional indicators
- How to trade with RSI like a pro
Features and Advantages of The RSI Indicator
As any other oscillator, the RSI indicator is not plotted on the price chart, but in a separate window below. This technical instrument consists of a single line and two levels set by default.
Vertical axis range of the indicator is set to 1 to 100 showing extremality of current price against its previous values.
RSI values calculation
U – average number of positive price changes
D – average number of negative price changes
What the formula means, is that if the price grows against previous values, so does indicator reading; otherwise, oscillator’s value goes down.
The RSI line may reach 0 or 100 only during strong, continuous downward or upward trend, respectively.
Usually standard overbought and oversold levels are 70 and 30. If the indicator’s line goes above the 70 level, it signals that market is overbought and the trend may reverse downwards.
If the indicator’s line goes below the level 30, it signifies that market is oversold and the trend may reverse upwards.
The reference level is 50, and it is the median value. If the indicator chart is ranging between the levels 30 and 70, the market is flat or that the current trend is smooth, steady and there is less of a likelihood for reversal in short-term
Sometimes, overbought and oversold levels are set at 80 and 20 instead of 70 and 30. This setting is used during increased market volatility.
Setting and Adjusting RSI Indicator
There are two ways to set up this indicator. The easiest way is to click the tab ‘List of Indicators’ located on the upper panel of the terminal and select ‘Oscillators’ – ‘Relative Strength Index’.
Another option is to choose ‘Insert’ – ‘Indicators’ – ‘Oscillators’ – ‘Relative Strength Index’.
Instrument configuration window will open before the indicator is set in the chart. This window allows you to configure the indicators parameters.
The main parameter is the period; It defines the number of price values taken into consideration at plotting the main indicator’s line. The shorter the period, the steeper indicator’s chart movements will be.
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 80. You can also add new levels should your trading strategy require so.
Opening Positions on RSI Signals
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.
When indicator’s line goes above the level 70 or below the level 30, it signals that market is overbought/oversold, and it is necessary to wait for the next signal confirming a trend reversal.
These are the rules for opening positions based on the RSI signals:
- If the indicator’s line crosses the level 70 from above, a short position (Sell) is opened.
- If the indicator’s line crosses the level 30 from below, a long position (Buy) is opened.
There are several conditions for closing a trade:
- Place a Stop Loss to local extremum and Take Profit to the value that is by 2-3 times greater.
- Exit on opposite indicator’s signal.
- Place a Stop Loss and Take Profit to the nearest key levels or Fibonacci (here Take Profit level should be not less than Stop Loss otherwise it is better to hold back and avoid opening a trade).
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.
Combined Strategy using Stochastic + RSI
In order to boost trading efficiency, it’s best to use the Stochastic Oscillator. The absence of trend indicators in this trading strategy is compensated by simultaneous analysis of two timeframes.
This way the oscillators will filter each other’s signals and trades will be opened only when both indicators give the same signals on different time frames.
This strategy suggests using time frames of Н4 and М15. In Н4, the RSI will have the default settings.
The only difference will be that instead of levels 30 and 70 we will set it at 50. In М15, Stochastic will have default settings.
Short position (Sell) will be opened in the following case:
- In Н4, the RSI line is crossing the level 50 from below.
- In М15, Stochastic lines exit overbought zone and heads down.
Long positions (Buy) will be opened in the opposite case.
Stop Loss and Take Profit are fixed and set at distances 20 and 50 points from the opening price respectively.
Such ratio enables to obtain a positive statistical expectation from trading in the long run.
It is recommended to check the economic calendar before opening positions in this trading system since the release of important news can significantly influence price movement, and technical analysis won’t be relevant at this very moment.
Advanced Strategy RSI + Stochastic + МА
Finally, let’s consider strategy with three classic indicators filtering each other as a single set and giving powerful signals for entering the market.
This strategy fits best for trading on Н1, Н4 and D1.
First, it is necessary to set up the following indicators in the chart:
- A moving average with the period of 10.
- An RSI with standard settings (levels 70 and 30).
- A Stochastic oscillator with standard settings (levels 80 and 20).
According to this strategy, a long position is opened when the following signals are generated:
- Price is crossing МА from below.
- RSI and Stochastic exit oversold zone.
All three signals should be received during three candles, otherwise, they will lose their value.
Short positions (Sell) should be opened in the opposite case.
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 abovementioned pattern.
The success of trading with an RSI depends on using additional indicators in conjunction with it.
Combined with the right indicators, RSI forms an efficient system, which can be fine-tuned by amending the parameters of instruments used.
Trading in financial markets puts your capital at risk. It is recommended to accurately follow the money management rules and always set Stop Losses to reduce risks. This article doesn’t constitute an investment/trading advice.