Technical indicator RSI is considered to be one of the most common on the Forex market. It belongs to the oscillators and is included to the standard package of trading platforms.
This indicator has a single line and is designed to determine the strength of the current trend, as well as its probable point of reversal. RSI compares the absolute value of the price increase on the Forex currency pair over a certain time period with a degree of its fall over the period. Results of calculations are displayed as a curve, where the display range can vary from 0 to 100%.
This indicator has a single parameter – the period that determines the length of the time interval which is applied in the calculations. The period, which is fixed by default is 14. This value can change depending on what activity is present on the foreign exchange market. It’s important to take into consideration that in case of an active market, the curve of this indicator will often cross the level 30 and 70%. However, in most of the cases this will not be the signals.
To screen out false signals in this case, the period can be increased, for example, up to level 21. It is necessary to shorten the period in such situation, when the market is calm, the signals will appear very seldom, and become completely ineffective.
Major trading signal is considered to be the divergence, i.e. a discrepancy in the testimony of RSI and behaviors of price movement of the currency pair. Though if the price makes several rising peaks and RSI curve shows on its chart in the same period two flowing maximums, it will mean that there is a weakening of the bullish force that may result in a reversal of the current uptrend or cause time correlation movement in the opposite direction. The opposite is right for a bearish trend.
If the market is in the high values of RSI for a long period of time, it is overbought, so there is a chance of a reversal in the opposite direction. The guarantee on the overbought can be given at indicator reading of 70%. Also, when the Forex market is in the underestimated indicator readings for a long time, the market will be oversold, i.e. prices are too low and the market may turn up. This situation occurs when the indicator values are below 30%.
It is recommended to enter and exit from the market when the indicators leave the overbought or oversold zones.
The central zone is between these two indicators. It is recommended to enter and exit from the market when the indicators leave the overbought or oversold zones. Otherwise, you should refrain from carrying out transactions on this currency pair.
This is explained by the fact that in a situation when the RSI is overbought, it indicates that the market has lots of buy positions and, of course, the selling would start in the nearest future. Signal will begin to appear, if the indicator breaks the level 80 downwards. At the same time, you can start selling. And if the indicator would touch the level 20 from the bottom up, it indicates the oversold.
It is necessary to use this indicator along with other tools of technical analysis of the Forex market, because it can often give conflicting signals. Prolonged oversold or overbought value, or strong price fluctuations reduce the effectiveness of this indicator. And, therefore, in a real trading strategy it should be used only after careful preparation.