THE RELATIVE STRENGTH INDEX (RSI)
Wherever there are humans and life around them, there’s an opportunity to trade. In our rather more modernized society, among other things, you can trade cryptocurrencies, equities, futures and forex. Opening a trade is very simple, but making sure it’s a profitable one, well, that’s challenging.
To make sure a trade is going to add value to your trading portfolio and is going to be worthwhile, you need to double-check with the indicators before you enter the trade. One of the very efficient and advantageous indicators is the Relative Strength Index, also known as the RSI.
Before we explain in-depth what the RSI is, allow us to give you a brief summary of what an indicator is.
An indicator is a tool used to help you better understand the markets so that you can take informative actions when it comes to your trades. In this article, we’ll be talking about one of our favourite indicators, the Relative Strength Index.
For starters, the RSI is an indicator (obviously?!). But to which type of indicators does it belong? Well, the RSI is a part of the big momentum indicators’ family. It tracks the strength of a certain momentum which shows the oversold or overbought conditions of the instrument at hand. Fairly enough, you get to benefit from the retracement of these conditions. The idea’s starting to clear up, yeah? Continue reading, things will sound so much easier as you go on.
According to the standard method, the RSI includes two levels: 70 and 30. Basically, when the RSI hits 70 or higher, we deduce that the asset has been overbought. We automatically understand that there’s an upcoming decline in its price. The other level gives us the following indications; when the RSI hits 30 or lower, then we can assume there’s going to be a price increase because the asset has been oversold.
Now that the basic understanding of what an RSI is got pretty clear, let’s take a look at how you can employ it in your trading platform. With the most popular trading platform being MT5, we’ll explain the step-by-step process of inserting the RSI indicator using that one.
Please open to your MT5 trading platform and look at the main menu where you’ll find the Inserttab. Press on it, then pick Oscillators. After that choose the Relative Strength Index. The picture below is a screenshot from our platform, take a look at it.
After selecting the Relative Strength Index, the below dialog box should be displayed on your screen.
There are three tabs in the dialog. Each tab is responsible for specific aspects of the RSI. The three tabs are the following; levels, parameters and visualization. Let’s take a tour and make a stop at each one individually.
In the Levelstab, you can add or remove levels.
As explained previously, the 30 and 70 levels are significant levels in the RSI. If you’re only interested in seeing the oversoldness or overboughtness of a certain instrument, keep the 30 or 70 levels as they are. But if you happen to be interested in other levels, the Levelstab is where you can play around with these and add the level you want. Simply press the Add button and type the level you want, say 50 for example, in the appropriate space.
If you’d like to spice up your chart, you can change the level’s colour. Normally, it’s silver but you can change it to any colour you like.
In the previous tab, you adjusted the levels. Now you can adjust the RSI line itself in the Parameters section.
In case you skipped the picture right above this paragraph, please go back to it and take a good look at it because we’ll be explaining every part of it.
Starting with the Period which represents the number of periods the RSI considers and follows when calculating the level. The number of periods depends on the timeframe you select. In case you have the 1-hour timeframe, for example, the RSI considers the last 14 instances (i.e. 14 hours). In another time frame, let’s say a 1-week time frame, you get to see the last 14 weeks. You get the idea…
In the Applyin the Parameters’ tab, you can determine the price the RSI should take into calculation. Default settings indicate Close, but we prefer the Typical Price which is derived from the formula: (High+Low+Close)/3.
The Style section is basically about you and your style since you get to pick the RSI line of your choice.
The last part of this tab has the Fixed Minimum and Fixed Maximumfeatures. They should be kept at 0 and 100 respectively. Removing the ticks makes the graph free-floating, you obviously don’t want that because it would change the window as the RSI increases or decreases.
The Visualizationtab allows you to choose how often you’d like your RSI indicator to appear, we mean in which time frames. As the above screenshot shows, All timeframes is selected, so you’ll see the RSI indicator in all timeframes. You have the option to see the RSI in specific time frames that you pick manually. What really matters is that you shape your charts in a way that pleases you and helps you trade better.
Things are starting to sound ridiculously easy regarding the RSI, right? Wait till you learn how to actually use it in trading. As I’ve mentioned twice before, the RSI shows a reading of above the 70 level when the instrument is overbought.
You know what it means for an instrument or asset to be overbought, right? It’s a bit late to define it, but just in case. When an asset or instrument is overbought, then the traders are buying these in excessive values. Typically, and after all this overboughtness, the prices will fall, then you can benefit by shorting (selling) the instrument.
In the graph below the RSI levels are above 70 in three different places, and in all three, the instrument’s prices fall shortly afterwards.
When the oil prices skyrocketed towards $27.90, the RSI reached around the 92 level. What does this level mean? Yup, you guessed it; severe overboughtness. Swift action is mandatory in such a situation before the prices drop towards $26.20. The chart above shows all of this.
In a different case, when the oil price hit around $27.05, with the RSI reached its 70 level. This caused another move downwards towards $24.50.
In the third attempt and as the price of the oil shot higher once again, it reached around the $27.90 price. At this level, the RSI to took the 70 level one last time sending the price down towards $24.50 once again.
The graphs above showcase just how important the RSI is in helping you pick strategic times to buy and sell. In the above example, the RSI helps in the case of trading AUDUSD. The currency pair first hit the 70 level on the RSI, shown as 0.6460 on the graph. This encouraged a move down towards the 30 level, which is represented by 0.6370 on the RSI.
After we saw the two trading opportunities in this graph, it’s only fair to say you have a much better understanding of the RSI. As a recap, you see, in the first example, RSI showed us when an instrument was overbought. This helps us understand that it’s safe to sell. Then, we saw when the RSI presented to us an oversold sold instrument which indicates a strategic time to buy.
Until Next Time,
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