What is RSI?
Relative Strength Index, or RSI as it is most commonly known, is a technical indicator that sees widespread uptake in forex arenas. Its appeal lies in its apparent simplicity. Basically, a momentum oscillator, RSI can be thought of as a graph that plots bearish and bullish sentiments with respect to previous highs and lows in trading ranges.
Ultimately, the plot consists of a 50% line, a 30% line and a 70% line. The latter two are most important since they are indicative of overbought and oversold signals – if a currency is trading above the 70% line then it is considered overbought and if the RSI value goes below 30 then the currency is considered oversold. However, some traders also use 20% and 80% lines instead of the aforementioned ones to be more certain of their actions and avoid trigger movements.
Furthermore, the central line is also important in its own right. It allows you to gauge the mood of the market. For example, if the currency is trading above this 50% line, you should expect bullish moves and if it is trading below it, then you should experience bearish sentiment on the trading floor. This is why many traders recognize this line as more of a support and resistance benchmark. If the currency is having trouble breaching the 50% line, then there is too much resistance during that time period and the price is more likely to go down again and again unless there is enough volume to overcome this resistance and break through. Similarly, the currency may find support at the 50% level and bounce off of it to continue its upward trend.
When using RSI, most traders use moving averages from either of the following two time-frames for their plots: a 10-day one or a 25-day one. It doesn’t matter which time period you choose, you will find that the Relative Strength Index forecasts an upcoming trend reversal faster than any other indicator employed in the market.
Failure Swing
One of the critical ways in which the RSI plot is going to help you in currency trading is by giving you very strong indications of trend reversals in the form of failure swings – both at the top and at the bottom of the chart. Here is how they materialize.
Say, a currency is trading and you have its RSI plot right in front of you. It reaches a high of 90 and then drops down to 80, it then rises again but doesn’t reach its previous high of 90. Say this time it reaches 86 or likewise. Now, the RSI is predicting a trend reversal in the form of the failure swing. As it crosses the last fall point of 80, it doesn’t rally again and continues sliding, triggering a sell signal.
Conversely, for example, a currency reaches a low of 20, then rises to 30, before falling again. However, the second time around it doesn’t slide to reach the previous low, thereby initiating another failure swing. Consequently, the prices will continue their upward trend, pass the last fall point of 30, meanwhile giving the traders a strong buy signal.
In conclusion, RSI is a critical indicator that will help you determine your entry and exit point efficiently, thus allowing you to make the right decisions on either side of the market.