RSI (relative strength index) explained
The RSI or Relative Strength Index is a powerful indicator to check whether there is still room for the current up- or downtrend to move further. In this article we discuss how to utilize the RSI.
What is RSI?
The RSI is a technical indicator that measures how often the price of a currency pair closes higher compared to the number of times that the price closes lower. This number is then compared to a number of periods in which the last data weighs heaviest. These measurements will yield a number between 0 and 100.
A figure above 70 indicates that the stock, commodity, or currency pair has been overbought, a figure below 30 indicates that the instrument is oversold. However, this does not mean you should immediately take a position: this number is merely an indication that the direction of the rate might reverse .
Setting the RSI
Within Plus500, it is very easy to set the RSI. Find the setup indicators within the toolbar and select the Relative Strength Index. By default the period is on 14, however it is recommended to use a period of 6.
Application of the RSI
You can use the RSI to check whether the current trend still has the strength to continue. With convergence it does indeed have the strength to continue, with divergence this is doubtful at least and a reversal might appear.
With convergence the RSI moves according to the trend and the most likely the trend will continue.
• Bullish: both the price and the RSI reach higher highs
• Bearish: both the price and the RSI reach lower highs
With divergence the RSI does not move in line with the trend and a reversal might take place.
• Bullish: the price reaches higher highs, but the RSI reaches lower highs
• Bearish: the price reaches lower lows, but the RSI reaches higher lows
A higher top is formed, but the RSI sets a lower top… here there is RSI divergence!
RSI as a trading indicator
The RSI is very useful to test your perception of the current market condition. Convergence confirms the current trend, while divergence increases chances of a reversal. If you take this into account you can be more successful in opening positions and make larger profits when trading Forex, commodities, or stocks.
Moreover, the RSI is essential for opening a position in case of a trend reversal: only in case of divergence is it wise to place a trade based on a trend reversal.