The Relative Strength Index (RSI) was developed by J. Welles Wilder. He introduced this in his book ‘New Concepts In Technical Trading Systems’ in 1978. RSI is an extremely popular indicator that is featured in a number of articles and books, and most of the professional traders around the world use this indicator in their daily trading activities.
It is a momentum indicator and it measures the magnitude of the price change in order to identify the overbought and oversold conditions. It consists of a line graph that moves between the two extreme areas and has readings between 0 to 100 levels. RSI oscillates between traditional levels of 70 and 30. If this indicator goes below 30, the market is said to be in an oversold condition and if it goes above 70, it can be considered as an overbought condition.
In an uptrend, RSI stays at 40 to 90 range while 40-50 zone acting as a support area. In a downtrend, RSI stays at 10 to 60 range, and 50-60 zone acting as a resistance area. A lot of amateur traders blindly buy the currency when the RSI is at 30 and sell it when the RSI hits the 70 levels. But this doesn’t work most of the time. It does work at times, but when you combine this with other indicators for confirmation, you can generate more genuine signals. We have discussed some of those strategies below.
RSI Indicator Formula
RSI = 100 – 100 / (1+RS*) * RS = Average gains / Average losses
Installing ‘Relative Strength Index’ in MT4 (step-by-step process)
The RSI is a standard Metatrader indicator and most of the brokers provide this in their terminal. Even in MT4, this indicator is present by default.
Open your MT4 terminal > click on Insert > Oscillator > Relative strength index.
A window will appear and here you can change the time period settings.
Click ‘ok’. As you can see in the image below, the RSI indicator is applied to a 60-minute EUR/USD chart.
Relative Strength Index – Trading strategy
RSI + MACD
In this strategy, we are combining arguably the two most reliable indicators, RSI & MACD. We recommend you to read our MACD article before going further.
The strategy is to see if the RSI is reaching the oversold area (30) and is giving a sharp reversal. At the same time, if the MACD line is crossing the signal line from below, it can be considered as a reliable buy signal.
As you can see in the below chart, the market is moving in ranges. Both the RSI and MACD indicators provide genuine signals in a ranging market. Since both of our indicators are at the oversold area and are giving a sharp reversal, it can be considered as a potential buy signal. Remember to close your trade once the RSI indicator reaches the oversold area and place your stop-loss order at the recent high.
If the RSI reaches the overbought area (70) and is giving a sharp reversal, half of our strategy is fulfilled. Now if the MACD line is crossing the signal line from above, it can be considered as a reliable sell signal.
As you can see in the below chart, both of our indicators are giving a sharp reversal once they reached the peak area. This can be considered as a potential sell signal.
RSI + RVI
Before going further, please consider reading our article on RVI.
In this strategy let’s understand how to generate trading signals by combining RSI and RVI indicators. For you to implement this strategy three things should happen.
- Both RSI & RVI should reach the overbought/oversold area
- RSI should give a sharp reversal
- RVI signal line should cross the RVI line
If all these conditions are satisfied, you can confidently trust those signals.
As you can see in the image below, prices are having a hard time to go higher. Both of our indicators are in the overbought area. RSI indicator is giving a sharp reversal. At the same time, the signal line on the RVI indicator crosses the RVI line. Hence it can be considered as a potential sell signal.
Most often, oscillators move in harmony with each other. So whenever you pair two oscillators together, always remember to use the same time period setting on both of them in order to get genuine signals. For instance, if you are using 14 periods on the RSI indicator, make sure to use 14 periods on the RVI indicator also.
In the below chart, the market is in a pullback phase. As we get deeper pullbacks, both of our indicators reached the oversold area. Quick reversals on both RSI & RVI indicate a potential buy signal. If this trade is taken according to this strategy, it would have given us a profit of 60 pips.
RSI is a leading indicator in the market, which still holds the top position, despite changes in volatility and the markets in recent years.
The Default time period setting for this indicator is 14 days. If the time period is lowered, the sensitivity of RSI increases, and if the time period is raised, its sensitivity decreases.
Traders typically combine support and resistance levels with RSI indicator to generate buy and sell signals. It is recommended to use this indicator with default time period settings if you are a novice trader. However, once you gain some experience, you can adjust the setting according to the market conditions and your personal preferences.
If you see the price of a currency making lower lows or higher highs, but RSI isn’t, it means there is a divergence in the market. This is the indication of a major price reversal.
Always confirm the RSI signals by combining this indicator with other reliable indicators as we have shown above in order to get extra confirmations. Let us know your thoughts about this indicator in the comments below.