There are so many strategies one can use in forex and other financial market to be profitable. We will examine the Relative Strength Index popularly known as RSI.
Relative Strength Index is one of the famous indicators used by both forex traders, stock traders and commodity traders etc. The RSI was developed by J. Welles Wilder and it is primary use to show the strength or weakness in a financial instrument, which in our case will be forex.
Before we can proceed, let us first have a brief look on the history of the RSI indicator.
History of Relative Strength Index.
The Relative Strength Index, which is also known as the RSI, is a technical indicator used in the analysis of financial markets such as forex, stock, commodities, etc. The RSI shows the strength or weakness of any particular financial instrument.
One of the popular periods the RSI is mostly used on is the 14-days period and the calculation used is applied to the closing price of the day. The RSI is measured on a scale of 0 to 100, where the high and low levels are sometimes marked at 70 and 30 or according to trading plan of the trader.
The high level, which is most time called the overbought level or zone, can be set to 90, 95, 80 or even 80 depending on the user’s choice. The low level referred to as oversold level or zone, which can have its levels set to 20, 25, 30 and 35 and is based on what the user wants.
If you want to know more about the Relative Strength Index. history, you can visit this link.
How to Use the Relative Strength Index (RSI).
The RSI is used to spot an uptrend and a downtrend and also to find potential supply and demand zones on the charts.
I will show you guys how you can use the RSI in your trading and be profitable. However, before we continue you will need to first understand that in this lesson we will use the 1-hour chart for all our examples.
Though you can use any timeframe which suite your “kind of trading such as 15 minutes or even using the daily chart remember it is purely based on you” .
To effectively use the RSI indicator, you will need to use the default setting which include:
- Period : 14
- Apply to : Close
- Levels: 70 Over Bought, 30 Over Sold
What the above means is that:
The period is how many days in the past that will be included which in our case will be 14 days.
Apply to, simply means that which we will be using the closing price in our calculations and nothing else.
The over bought and over sold is just only indicating where will be considering, before we take a trade.
How is the RSI Calculated?
We will not go into much detail about how the RSI is alculated. The general formula used is RSI = 100 – [100 / ( 1 + (Average of Upward Price Change / Average of Downward Price Change ) ) ]. Since this article isn’t about how the RSI is calculated, we will just skip this part and head to the fun part I am going to show to guys how you can trade the intraday using this wonderful startegy.
Before I proceed, I want to make some something clear to everyone reading this.
“When I say intraday, I am taking about timeframe below the daily time frame such as 4 hour, 1 hours, 30 minutes, 15 minutes, 5 and 1 minutes though the two best time frame I would recommend you test it on are the 1 hour and 4hours but in this article we will use the 1 hours chart”
NOTE: on the pictures below, you will see three colors, which are BLACK, GREEN and RED.
BLACK is used to show the point where a trade signal appeared, so whenever you see the black line look at the over either sold or over bought level.
GREEN is used to show areas where the news had an influence in a candlestick I recommend you read How to Ride the News in Forex Trading.
RED is used to show the direction price went in our favour after the trade signal has appeared.
As I have said, we will use the 1-hour chart on AUDUSD
The BLACK line shows the zone where the trade signal was trigger and in this case, it was at the overbought level.
The RED arrow line shows us the direction which price went and we can see that it went in our direction, which is bearish.
The GREEN circle is used to pin point areas, which were influenced by unexpected news in the market. For example if you look at the area between the red arrow and the green circle we can see that the candle stick did not reach the oversold zone. So we cannot pull any trade because our trade setup is not yet confirmed that is also one thing we should ALWAYS PUT INTO CONSIDERATION.
The next example is
If we look at this example above, we can see that there were many trading opportunity.
The first trade call was a bullish, then supply exceeded demand and immediately price started dropping. The third trade signal, price fell before going bullish again.
The chart above is more of a ranging market than a trending one, when price finally reached the oversold level. It further moved by few pips before demand creeped in to rise the price up and then we saw another market event, which made the price to fall.
The last example
Looking at this chart you will notice a ranging market. At the first stage price reached the oversold level and immediately demand rose up. The green circle shows us the effect of news.
From the examples above we can see how amazing this strategy is but there are some drawback such as market volatility, there are some times when news will greatly influence the price movement and in such cases you might see some fake trade setup or candle stick spikes.
That is why you should also be mindful on when and how you enter into the market to take a trade. Take for example we know that when price hit the 70 mark on RSI, it is the overbought zone, so therefore we should always wait until it has confirm that price has reach that zone before placing your trade.
The next challenge is the placement of stop loss and take profit, when placing your stop loss you should place it on areas, where you know that when price such areas it shows your trade set up was invalid.
This is because price does not move in a straight line. The same thing applies to your take profit; it should be placed on key areas such as using support and resistance or Fibonacci Retracement level .
CHECK THIS: How to scalp effectively using pivot point
EMOTION too plays a vital role, do not always be excited that all your trade will be a winner or in profit, learn to accept losses and remove greed from your trading, I know it is easier said than done but if you apply this principal everyday then you will soon learn the act of trading.
I will love to hear from you so place do comment below.