RSI is one of the most popular Technical Indicators in the market. Here is How Trading Pros Use the Relative Strength Index
Technical analysis is one of the most popular trading methods in the market. Unlike fundamental analysis, technical analysis uses technical indicators to predict the future direction of an asset. These indicators are developed using complex mathematical calculations.
There are hundreds of indicators in the market today. Most of these indicators were developed decades ago and are still in use today. The Relative Strength Index (RSI) is one of the most popular technical indicators in the market.
In this article, we will look at what RSI is and how you can use it in the market.
What is the Relative Strength Index (RSI) indicator?
The RSI was developed in the 1950s by Welles Wilder. Wilder was a well-known trader and author who is also credited for developing other indicators. The RSI is a momentum indicator that measures the speed and change of price movements.
It is an oscillator that moves from zero to 100.
Relative Strength Index Calculation and Formula
The RSI is calculated using a very simple formula. First, you calculate the Relative Strength. This is done by dividing the average gain with the average loss during a particular period. The most popular period is 14 days.
You then add the RS with 1. You divide the result by 100. The final RSI number is derived by subtracting this result from 100. As with all the other indicators, you don’t need to do these calculations by yourself.
The best approach is to simply know how to apply and interpret them.
How to Use the Relative Strength Index (RSI)
There are several approaches of using the Relative Strength Index. First, you need to ensure that the pair is following a trend. This trend could be in each direction. The reason for this is that it is that it is usually almost impossible to get a real signal when the financial asset is consolidating.
When an asset is consolidating, the RSI will often be at the middle.
Second, you need to check the period of the RSI. Most trading platforms use 14 as the default period, because it works well in most scenarios. However, you can change it depending on your trading strategy.
The first common approaches to use the RSI is to identify the oversold and overbought level. A financial asset is said to be oversold when it has moved so much lower. An RSI level below 30 is said to be oversold.
Most traders view this situation as the best place to buy an asset. The opposite of being oversold is being overbought. A level above 70 is said to be overbought. Most traders use it as an ideal level to short.
You can see a good example of this on the chart above. The blue arrows show the points when the pair was oversold while the red points show when it was oversold.
Another approach is to do the opposite. This means buying when it is overbought and selling when it is oversold. The thinking is that a pair will continue moving in one direction even after reaching the overbought and oversold levels.
The first approach is usually more appropriate because that is how most traders use the RSI. You should always ensure that you have use additional indicators. This will help you confirm a new trend and avoid a false breakout.
External useful resources
Is RSI a good indicator for trading and investing purposes? – Quora
How to use the relative strength indicator (rsi) for Day Trading – Tradingsetupsreview
Relative Strength Index – Stock Chart School