This is the second article in our RSI series. If you haven’t already we suggest that your check out the first article about the RSI Indicator. In that article, we covered the background of the “Relative Strength Index”, or “RSI”, indicator, how it is calculated, and how it looks on a chart. 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.
The RSI is classified as an “oscillator” since the resulting curve fluctuates between values of zero and 100. The RSI indicator typically has lines drawn at both the “30” and “70” values as warning signals. Values exceeding “85” are interpreted as a strong overbought condition, or “selling” signal, and if the curve dips below “15”, a strong oversold condition, or “buying” signal, is generated.
How to Read a RSI Chart
The RSI with a period setting of “8” is presented on the bottom portion of the above “30 Minute” chart for the “GBP/USD” currency pair. In the example above, the “blue” line is the RSI, while the “red” line, added as an additional option on the “Metatrader 4” platform, represents an exponential moving average for eight periods. RSI values below 30 and over 70 are worthy of attention.
The key points of reference are highpoints and lowpoints, especially when respective values cross 15 or 85. The “RSI Rollercoaster” tends to work better for longer timeframes, i.e., daily, but shorter periods can be accommodated as shown here. The RSI attempts to convey pricing momentum, but sideways action in the market can confuse. In the above chart, four overbought and four oversold conditions are evident by virtue of the various “limit” crossovers.
As with any technical indicator, an RSI chart will never be 100% correct. False signals can occur, but the positive signals are consistent enough to give a forex trader an “edge”. Skill in interpreting and understanding RSI signals must be developed over time, and complementing the RSI tool with another indicator is always recommended for further confirmation of potential trend changes.
In the next article on the RSI indicator, we will put all of this information together to illustrate a simple trading system using this RSI oscillator.
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