The Relative Strength Index, or RSI, is a prominent indicator invented by J. Welles Wilder, a technical analyst, that helps traders assess the strength of the current market.
RSI, like Stochastic, indicates overbought and oversold circumstances in the market.
It is also a 0 to 100 scale.
Readings of 30 or less typically suggest oversold market conditions and a rise in the likelihood of price rising (going up).
Some traders take an oversold currency pair as a sign that the declining trend is about to reverse, implying that it’s a good time to buy. Readings of 70 or higher suggest overbought conditions and an increased likelihood of price weakness (going down).
Some traders perceive an overbought currency pair as a sign that the upward trend is about to reverse, implying that it’s time to sell.
Traders that employ the Relative Strength Index (RSI) indicator look for centerline crossovers in addition to the overbought and oversold indicators discussed above.
A move from below to above the centerline (50) suggests a rising trend.
When the RSI value crosses ABOVE the 50 line on the scale, it moves towards the 70 line, indicating a rising centerline crossover. This shows that the market trend is strengthening and is interpreted as a bullish signal until the RSI approaches the 70 line.
A move from above to below the midline (50) suggests a downward trend.
A falling centerline crossover occurs when the RSI value falls BELOW the 50 line on the scale, approaching the 30 line. This shows that the market trend is weakening and is interpreted as a bearish signal until the RSI approaches the 30 level.
How to Trade Using RSI
The RSI indicator, like the Stochastic indicator, can be utilized in the same way.
It can be used to forecast probable tops and bottoms based on whether the market is overbought or oversold.
The EUR/USD 4-hour chart is shown below.
The EUR/USD had been sliding all week, losing around 400 pips in two weeks.
It was already trading below the 1.2000 level on June 7.
However, the RSI fell below 30, indicating that there may be no more sellers in the market and that the advance may be over.
Price then reversed and began to rise again over the next few weeks.
Determining the Trend using RSI
The RSI is a well-known tool since it may be used to confirm trend patterns.
If you believe a trend is developing, check the RSI and see if it is above or below 50.
If you’re looking for an UPTREND, make sure the RSI is above 50.
If you’re looking for a prospective DOWNTREND, make sure the RSI is less than 50.
A probable downturn was forming at the beginning of the chart above.
We can avoid fakeouts by waiting for the RSI to go below 50 to validate our trend.
When the RSI falls below 50, it is a good indication that a downtrend has developed.
Next Lesson: How to Use Williams %R (Williams Percent Range)