RSI Indicator Forex Trading Strategy
Relative Strength Index or RSI is the most popular indicator used in Forex trading. It is an oscillator indicator which oscillates between 0 -100. The RSI is a trend following indicator. It indicates the strength of the trend, values above 50 indicate a bullish trend while values below 50 indicate bearish Forex trend.
The RSI measures momentum of a currency.
The centerline for the RSI is 50,crossover of the centerline indicate shifts from bullish to bearish and vice versa.
Above 50, the buyers have greater momentum than the sellers and price of a currency will keep going up as long as RSI stays above 50.
Below 50, the sellers have greater momentum than the buyers and price of a currency will keep going downwards as long as RSI stays below 50.
In the example above, when the RSI is below 50, the price kept moving in a downward trend. The price continues to move down as long as RSI was below 50. When the RSI moved above 50 it showed that the momentum had changed from sell to buy and that the downtrend had ended.
When the RSI moved to above 50 the price started to move upwards and the trend changed from bearish to bullish. The price continued to move upwards and the RSI remained above 50 afterwards.
From the example above, when the trend was bullish sometimes the RSI would turn downwards but it would not go below 50, this shows that these temporary moves are just retracements because during all these time the price trend was generally upwards. As long as RSI does not move to below 50 the trend remains intact. This is the reason the 50 mark is used to demarcate the signal between bullish and bearish.
The RSI uses 14 day period as the default RSI period, this is the period recommended by J Welles Wilders when he introduced the RSI. Other common periods used by forex trader is the 9 and 25 day moving average.
The RSI period used depends on the time frame you are using, if you are using day time frame the RSI 14 will represent 14 days, while if you use 1 hour the RSI 14 will represent 14 hours. For our example we shall use 14 day moving average, but for your trading you can substitute the day period with the time frame you are trading.
To Calculate RSI:
- The number of days that a currency is up is compared to the number of days that the currency is down in a given time period.
- The numerator in the basic formula is an average of all the sessions that finished with an upward price change.
- The denominator is an average of all the down closes for that period.
- The average for the down days are calculated as absolute numbers.
- The Initial RS is then turned into an oscillator.
Sometimes very large up or down movement in price in a single price period may skew the calculation of the average and produce a false signal in the form of a spike.
Center-line: The center-line for RSI is 50. A value above 50 implies that a currency is in a bullish phase as average gains are greater than average losses. Values below 50 indicate a bearish phase.
Overbought and Oversold Levels: Wilder set the levels at which currencies are overextended at 70 and 30.