2024 Author: Howard Calhoun | [email protected]. Last modified: 2023-12-17 10:16
Almost any trading platform includes such a tool as the RSI indicator (an abbreviation of the Relative Strenght Index), also called the Relative Strength Index. Belonging to the class of oscillators, it is able not only to determine the strength of the current trend, but also, in combination with the price chart, to give a timely signal about its upcoming change.
Who and when invented the RSI indicator
The inventor of this tool is an American mechanical engineer J. Welles Wilder Jr., better known for his work in the field of technical analysis. He is also the creator of such well-known indicators among traders as ADX (Average directional movement index), ATR (Average true range) and Parabolic SAR.
Introduced in 1978, the Forex RSI indicator was originally created to analyze stock charts and financial indices. Nowadays, this indicator is widely used in the foreign exchange market.
Description of the RSI indicator
According to Wilder, the construction of the curve of the rate of price change is very difficult. Firstly, because of the randomness of the movement, and secondly, because of the lack of a permanent boundaryoscillator bands that allow comparative analysis. The algorithm for describing the RSI indicator successfully deals with these two problems - it not only smoothes the curve, but also has a vertical scale with values from 0 to 100.
RSI=100 - [100/(1+RS)], where RS is the quotient of the average of the high closing prices to the average of the low closing prices over a given period of time. By default, the value of the time interval is 14. If necessary, you can change it at your discretion, depending on the activity of the market.
When the indicator is below 30, it is considered to be in the oversold zone, if the RSI indicator is over 70, it is considered to be in the overbought zone.
RSI trading signals
The popularity of this indicator is the ease of interpretation of its signals. If the RSI line crosses level 70 downwards, it is a signal to open a short position (sell), and from below level 30, a long position (buy). Crossing the level of 50 in this case is another sign of confirmation of the correctness of opening a position.
In general, the RSI indicator can be used as a filter - i.e. if it is in the overbought zone, you should refrain from buying, and if you are in the oversold zone, you cannot sell.
One of the strongest signals when conducting technical analysis, of course, is a divergence - that is, contradictions in the indicator readings (not necessarily RSI) and the price chart. As an indicator of divergenceRSI can be successfully used to detect a change in trend and a price reversal.
RSI can also be successfully used to identify reversal patterns (for example, head and shoulders, triangle, pennant, etc.), and these patterns may not form on the price chart.
Disadvantages of the RSI indicator
Like any other tool, the RSI indicator is not without flaws. Perfectly working in the sideways market, it gives a large number of erroneous signals when the trend develops. Therefore, its signals can only be used as recommendations and only in combination with other technical analysis tools available to the trader.
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