This is the third article in our RSI series. If you haven’t already, we suggest that you check out the first article about the RSI Indicator. In the previous two articles, we have covered the background, the calculations involved, and how to use and read the RSI indicator. The RSI measures the relative changes that occur between higher and lower closing prices. Traders use the index to determine overbought and oversold conditions, valuable information when setting entry and exit levels in the forex market.
Forex traders focus on the RSI key points of reference, which are highpoint and lowpoint limit crossovers. As with any technical indicator, an RSI chart will never be 100% correct in the signals that it presents, but the signals are consistent enough to give a forex trader an “edge”. Skill in interpreting and understanding RSI signals must be developed over time. In the example below, let’s develop a simple trading system based on RSI signals and alerts.
The following trading system is for educational purposes only. Technical analysis takes previous pricing behavior and attempts to forecast future prices, but, as we have all heard before, past results are no guarantee of future performance. With that disclaimer in mind, the “green” circles on the above chart illustrate optimal entry and exit points that can be discerned from using RSI analysis in combination with the added EMA in red.
A simple trading system would then be:
- Determine your entry point when the “blue” line dips below the “30” lower limit line and the EMA “red” line crosses the RSI in a downward motion;
- Execute a “Buy” order for no more than 2% to 3% of your account;
- Place a stop-loss order at 20 “pips” (75% of the ATR value shown) below your entry point;
- Determine your exit point when the RSI crosses the “70” upper limit line and is accompanied by a nearby crossing of the EMA “red” line in an upward movement.
Steps “2” and “3” represent prudent risk and money management principles that should be employed. This simple trading system would have yielded three profitable trades of 80, 100, and 150 “pips”, but do remember that the past is no guarantee for the future. However, consistency is your objective, and hopefully, over time, RSI Technical Analysis will provide you with an “edge”.
That concludes our series on the RSI Indicator. For further reading please visit our Forex indicators section.
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