Relative Strength Index, or RSI, is a favourite amongst many bank traders. It is a momentum indicator that helps identify the trend and potential overbought and oversold areas in the market. The indicator’s scale ranges from 0 to 100. Usually, readings below 30 indicate oversold and readings above 70 indicate overbought.
Click to enlarge
When the indicator is showing the market as overbought or oversold, a top or bottom may be forming. It is during these times that traders typically look to enter trades, close any open trades or tighten their stop losses.
The middle 50 line of the RSI is also used to identify a potential trend.
Click to enlarge
During times of an uptrend, it is preferred that the indicator should be above the middle 50 line. For downtrends, it is ideal that the indicator be below the 50 line.
Much like the stochastics indicator, RSI is also a momentum indicator and may warn of potential turning points in the market when momentum begins to drop.
Click to enlarge
In the above example, price is in a clear down trend making lower lows. However, RSI is making higher lows and shows a clear divergence with price. This is a common sign of a loss of momentum in the market and may warn of a potential turning point before the market pulls back.
RSI, like any indicator is not perfect. One should never enter a trade blindly using RSI. Instead, any signals given by RSI should be confirmed with either price action or support and resistance levels.
Comments on this entry are closed.