As part of almost any trading platform , there is necessarily such a tool as an RSI indicator (abbreviation 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 conjunction with the price chart in a timely manner to signal about its upcoming change.
Who and when came up with the RSI indicator
The inventor of this tool is the American mechanical engineer 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 market 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 a curve of the rate of change in prices is very difficult. Firstly, due to the randomness of the movement, and secondly, due to the lack of a constant boundary of the oscillator band, which allows a comparative analysis. The RSI indicator description algorithm successfully fights these two problems - it not only smooths 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 value of upper closing prices to the average price of lower closing prices for a given period of time. By default, the time interval is 14. If necessary, you can change it at your discretion depending on market activity.
If the indicator is below the value of 30, it is considered that it is in the oversold zone, if the RSI indicator has a value of more than 70 - in the overbought zone.
RSI Trading Signals
The popularity of this indicator is the ease of interpretation of its signals. Crossing the RSI line of level 70 in the direction from top to bottom is a signal to open a short position (for sale), and from the bottom up to level 30 - long (for purchase). The intersection of level 50 in this case is another sign of confirmation of the correct opening of a position.
In the general case, the RSI indicator can be used as a filter - that is, when it is in the overbought zone, you should refrain from buying, and when you are in the oversold zone you cannot sell.
One of the strongest signals in conducting technical analysis, of course, is divergence - that is, contradictions in the indicator readings (not necessarily RSI) and the price chart. As an indicator of divergence, RSI can be successfully used to determine a trend change and a price reversal in the opposite direction.
RSI can also be successfully used to determine reversal patterns (for example, “head and shoulders”, a triangle, a pennant, etc.), and these figures may not form on the price chart.
Disadvantages of the RSI indicator
Like any other tool, the RSI indicator is not without drawbacks. Works great in the side market, it gives a large number of erroneous signals during the development of the trend. Therefore, its signals can be used only as recommendations and only in combination with other technical analysis tools available to the trader.