Forex RSI indicator

Forex RSI indicator

RSI indicator – a tool for a successful Forex trader

According to statistics from search engines, MACD accounts for 4 691 queries per month. They search for Stochastic 3,744 times, another 2,404 requests fall on the word Stochastic. And if you still believe these statistics, then the RSI is searched for 10,075 times a month. Whether this is due to the popularity of the oscillator itself or is it a matter of a simple convenient abbreviation is a rhetorical question. But the fact remains: RSI is one of the most popular indicators of technical analysis, which means that it is worth paying attention to.

From this review you will learn:

  • What is it: the essence and formula of the calculation, setting the RSI indicator.
  • How to use: trading on the RSI indicator, a brief description of the signals.
  • Advantages and disadvantages of the indicator.

And also get acquainted with practical examples of using RSI and its modified versions with detailed analysis of input and output signals, screenshots and recommendations.

RSI indicator: from theory to practice

RSI (Relative Strength Index) – Relative Strength Index, an oscillator developed in 1978 by Wells Wilder. This year it was first published in the magazine Commodities and was later reviewed in detail by the author in the book “New Concepts in Trading Systems”.

The indicator displays “momentum” – the speed and amplitude of the change in price movement, that is, the strength of the trend and the likelihood of a change in its direction. The greater the total length of candles of the same color over a fixed period, the closer the indicator is to the borders of its corridor.

The indicator formula is as follows :

  1. U (positive price change) and D (negative price change) are calculated:
  • If the closing price of the current candle (1) is higher than the closing price of the previous candle (2), then U = Price (1) – Price (2), D = 0. 
  • If the closing price of the current candle (1) is less than the closing price of the previous candle (2), then U = 0, D = Price (2) – Price (1).
  1. RS (relative strength) is calculated. RS = EMA (U) / EMA (D), where EMA is the exponential moving average. The use of EMA in the calculation of RS is not the only one. There are variations in the use of SMMA (Smooth Moving Average) and even SMA. There is clarification regarding SMA (simple moving average): a situation may arise when the denominator is zero. Then the RSI should be considered equal to 100.
  2. RSI = 100 – 100 / (1 + RS).

Simply put, RSI compares the arithmetic mean of positive and negative price changes. If there are more positives, the indicator grows, less – decreases. 

The only indicator parameter is the period, that is, the number of candles whose closing prices are used in the formula. The maximum value of the indicator is 100, the minimum is 0. 

The key levels, which are the boundaries of overbought and oversold zones, are 70 and 30.

RSI Indicator Signals :

  • U-turn in overbought and oversold zones. The analogy of the principle of trading in stochastics with only one difference: a less rigid link to the levels. If the stochastic “20/80” levels almost never change, then with RSI there are strategies with both “20/80” and “30/70” levels. Otherwise, the essence is the same: if the indicator reverses at overbought or oversold levels and intends to exit from them, a signal for a trend reversal.
  • Divergence / convergence. “The most reliable signal of the RSI indicator is a discrepancy with the indicators on the price chart,” the author of the tool expressed this opinion. True, this statement applies to many technical tools.

The RSI indicator is universal. It can be used on any timeframes, evaluate the price trend of not only currency pairs but also securities, etc. But not everything is so perfect. For example, traders call the main drawback the fact that RSI can take a horizontal position in overbought and oversold zones and hang around there for a long time. Another problem is redrawing on the last candles. But any indicator has disadvantages. And it is worth noting that RSI is most often not a primary indicator, but a filter.

RSI has a lot of modifications and they were created mainly through a combination with other basic indicators. For example, MA or Bollinger Bands. You yourself can experiment with creating such combinations. You can do this as follows:

  • Open RSI.
  • Drag onto the RSI chart, for example, MA.
  • In the properties of the MA indicate: “Apply to – First Indicator’s data”

I’ll go directly to practice.

RSI and its modifications: interesting non-standard strategies for gaining experience

The strategies presented below are an example of a non-standard application of RSI, which acts here as modified versions or as embedded code in a combined indicator. The strategies describe the essence and principle of operation of indicators, the rules for opening and closing deals, screenshots are given. Each strategy has a free link to template archives, installation instructions for which are in the second part of this review.

For those who like to criticize technical analysis, they call indicators inoperative and have the habit of calling strategies “merging” without arguments, I focus on the following points:

  • These strategies are just a basic model! No one can guarantee that any tactics or indicators will always be profitable. These models teach how to work with indicators and catch signals, they help to develop intuition and attentiveness and teach to understand the market. If you are determined to start earning on them from the first minutes, I will disappoint you, this is not the Grail. 
  • Testing is the first step in working with a strategy. MT4 tester, manual testers for Metatrader (manual testing is longer but more reliable) – there are many options. After testing, depending on the timeframe, run the strategy on a demo account. On average, to evaluate the effectiveness of the system, you need to complete from 100-150 transactions. Experiment: overlay other indicators, change settings, add levels or track patterns. The trading model should be convenient especially for you!
  • Patience is the key to a trader’s success. If guided by the recommendations on entering the market, you have received a loss, this does not mean that the strategy is not working or problems with the indicator. Maybe you do not quite accurately interpret the signals or you need to optimize the system. 

Could refine the proposed trading strategy even better – share your success in the comments. Let’s create the perfect tool together!

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