How to use the RSI indicator which is effective in trading analysis on the forex market or crypto market?
For those of you who love technical indicators, certainly already familiar with the Relative Strength Index indicator or RSI,
The RSI indicator has a function similar to the stochastic indicator.
To find out the price is already at the overbought and oversold levels.
Through the RSI level on a scale of 0-100.
In addition to the RSI oscillator indicator, James J Wilder also discovered the Average True Range, Average Directional Index, and parabolic SAR which as indicator trend following that we learned in the previous chapter.
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Relative strength index (RSI) definition
The definition of RSI is a technical indicator that measures the magnitude of price changes within a certain period to analyze the condition of a trading asset that has reached the overbought and oversold area.
The RSI indicator is mainly to identify oversold and overbought levels of an investment asset and as triggers trading signals.
The RSI is a technical indicator of the Oscillator type which is included as a leading indicator (preceding price movements).
J. Welles Wilder uses period 14 as the default setting on the RSI indicator.
But you can change the period to suit your needs with a longer or shorter period.
The way to read the RSI indicator is to pay attention to the level of scale.
- Which if the RSI scale shows above 70 then the trading assets have reached the overbought level.
- But if the RSI scale shows a scale below the number 30 then this gives an indication that the trading assets are at the oversold level.
How to calculating the value of the RSI indicator, there are several components that must be calculated first.
These components are RS, average gain, and average loss.
RS = Average price increases in periods when prices rise during certain time frames, or average price decreases in periods when prices fall during certain time frames.
If using the standard period from Wilder, the calculation formula is:
RS = Average gain / average loss Average gain = (previous average gain x 13) + last gain) / 14 Average loss = (previous average loss x 13) + last loss) / 14
Average gain or loss is the difference in the outcome of a market closing price.
For example, suppose the price 1 hour ago was closed at level 2, while the current price is at level 5, there is an increase of 3 points.
This increase will be counted for 14 candles in each time frame. And to calculate the value of the RSI indicator will use this RS value
The following formula is
RSI (Relative Strenght Index) = 100 - ( 100 / ( 1 + RS ))
On forex trading platforms like Metatrader, the RSI indicator appears in the window below the price, this is a line-up and down like Stochastic, it’s just a little smoother compared to the stochastic line.
Even though you understand how to calculate this indicator, you don’t need to draw it manually, because to call the RSI indicator just click at the top menu, Insert –> Indicators –> Oscillators –> Relative Strength Index.
The default period setting is 14
Using the default 14 RSI setting gives a slower signal than the Stochastic indicator, even using the daily timeframe, the RSI line will be far less likely to reach overbought and oversold levels than the stochastic.
Thus the signal given will be even less and if you use an overbought and oversold as the signal trigger, you have to wait a long time to find the RSI arrived at these levels.
But if you use RSI to determine an uptrend or downtrend, you need to add level 50 as a basis for analysis.
Simply to add level 50 you just need to click RSI properties and then modify the level setting then add level.
If the RSI line is above level 50 it means that the trend is going up, on the contrary, if the RSI is below level 50 it means the trend is going down, you might use an RSI crossing with level 50 as a trigger signal entry.
How to use RSI
How to use the RSI indicator is similar to using the stochastic indicator, because both of these indicators have the same function to determine the overbought area and the oversold area.
Thus what the trader must do is wait for the RSI level to reach above the 70 levels to determine to Sell positions, and wait for the RSI level to reach the level below 30 to determine the Buy position.
Looks simple, and indeed this is simple, what makes it complicated is your patience waiting for RSI to reach that level and other problems when RSI gives fake signals.
But okay, regardless of fake signals that may exist, I will give an example of how to trade using the RSI indicator.
Below this is the EURUSD chart with the H4 timeframe.
In the chart above EUR / USD has been going down for two weeks around 400 pips.
On June 7, the pair was traded below the 1.2000 level.
However, the RSI fell below the 30 scales, which means that it might be that sellers are starting to reduce their volume and this might be the time to reverse.
And see what happens then, if you open buy in the zone then you will pocket a number of pip profits.
Because prices then reverse and rise again over the next few weeks.
And the signal from the RSI which suggests the price has entered the oversold area turned out to be valid, so then the price rises after a long decline.
Conversely, if the RSI has entered the overbought area then you will consider it to be a trigger signal to open short positions.
How to determine the trend with RSI
Some traders use the RSI as a toolbox that serves as a determinant of the direction of the trend.
This requires a little improvisation of your creativity.
Because you still need to add level 50 as a basis for determining the uptrend or downtrend.
Basically the RSI scale is from 0-100, so with an additional level 50.
This is the midpoint of the scale, a kind of fixed pivot point.
Then how do you read the RSI to determine the trend?
Simple, you just make sure if the downward trend RSI is below the level of 50, if it hasn’t crossed the level 50 then based on this indicator it doesn’t show a downtrend.
For the reading of the uptrend, it’s the same, you just need to make sure that the price is above level 50.
When you see the trend starting to rise, but the RSI is still below level 50, it means that based on this indicator has not reached an uptrend.
It’s very simple, that’s why many traders like to rely on technical analysis?
Because of the ease of reading the toolbox as a trading aid.
If you are going to use the RSI to trigger the entry point by determining the trend.
You can use the RSI across the 50 scale line.
So, for example, you will open Sell, you will wait for the RSI to cross the 50 scale line from top to bottom.
And vice versa for Buy positions.
You will wait for RSI to cross the 50 scale line from the bottom to up as a Buy signal.
The above example is a way of trading using RSI crosses.
At first, the trend seems to be down.
But to make sure that it will actually go down.
You wait for the RSI to cross the 50 scale line.
And finally quite convincing after RSI passed the 50 scale line.
Advantage and disadvantage using RSI
As with most indicators that have advantages and disadvantages, here are some things that relate to the RSI indicator.
- + This indicator is not as aggressive as the stochastic indicator, so fewer signals appear, and this reduces the risk factor.
- + In addition to determining the overbought and oversold areas, this indicator is also to determine the direction of the trend and signal entry.
- + This indicator is included as a leading indicator so that it is possible to get a signal earlier.
- – This indicator may also find fake signals that appear due to the dynamic nature of price changes.
RSI is a technical indicator that is popular among forex traders, how to use it is also easy and simple.
Although it is possible if the calculation of the formula is quite complicated when drawing manually.
But you don’t need to bother and mess around with this problem.
Because this indicator will automatically calculate through the graph.
And of course to get more experience you have to try a lot.
Because sometimes a newbie does not want to be patient when choosing indicators in the toolbox.
After trying once or twice it fails, then looks for other indicators to replace.
So that understanding of the characteristics of indicators is not good.
Again, you can take advantage of the demo account facility provided by the broker, most brokers provide this feature so you don’t need to worry.
Footage for the next lesson chapter is about William Percent Range.