In this article, Forex Trading will explore with you the RSI Index . This is one of the popular tools chosen by many investors to analyze the forex market. The article will focus on explaining the meaning of RSI divergence and how to apply it in investing along with other information you need to know. Let’s follow along!
Learn in-depth about the RSI index
The RSI index is the abbreviation for Relative Strength Index. This is a technical analysis tool that was launched in 1978. It became extremely popular in the trading community.
What is RSI?
RSI stands for Relative Strength Index, i.e. Relative Strength Index. This is a popular indicator in technical analysis. Often used to measure recent price movements. This index provides an assessment of the higher buying or selling conditions of a stock or other asset.
RSI is often represented as a graph. There is a line moving between two extreme points. This is called the dynamic range, and its value typically ranges from 0 to 100.
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Formula to calculate RSI index
RSI is calculated in two steps, starting from the following formula:
RSI = 100− 100/(1+RS)
Trong đó: RS= Average loss/Average gain
The average gain or loss used in this formula is the average percentage gain or loss over a given period of time. This average loss is used in the formula with a positive value.
During a losing period, the average profit will be calculated as 0. While during a profitable period, the average loss will be calculated as 0. The default calculation is to use the value over 14 trading sessions to calculate the RSI initial.
For example: Out of 14 days, the market closed at a higher price than in 7 days. The average increase is 1%. With the remaining 7 days, the market closed at a lower price with an average loss of -0.8%.
- The initial value of RSI will be calculated as follows: RSI=100− 100/(1+ 1/−0.8%)
- After having data for 14 sessions, the second step of RSI is calculated with the following formula:
RSI=100− 100/(1+[Previous average loss×(Current Loss−Previous average loss)] / [Previous average gain×(Current Gain−Previous average gain)]
By using these formulas, a technical analyst can calculate the RSI value. The RSI will increase as the number and size of closes at the price level increase. The second step of the calculation will make the results more accurate and eliminate noisy data.
RSI divergences and the meaning of the RSI line in forex
Divergence occurs when the price of a symbol (or asset) moves in the opposite direction compared to a technical indicator, like Pivot Points. This warns that the current price trend may be weakening. There is a risk of a change in price direction.
When the RSI is at an oversold level, a bullish divergence occurs. RSI creates a high low while falling prices create a low low. This phenomenon is called positive divergence and warns of strong upward momentum. Don’t worry about the downward trend in price.
When the RSI indicator is at overbought levels, a bearish divergence will occur. RSI creates a low peak while rising prices create a high peak.
Meaning: The RSI line helps investors identify overbought or oversold conditions in the market. When the RSI is below 30, the price is near the bottom, and when the RSI is above 70, the price is near the top, and risk is reduced. Investors use RSI to understand trends and predict future price reversals.
Methods of applying the RSI index in trading
There are many ways to apply the RSI index to forex trading effectively. Here are some methods of using RSI:
Use a combination of SMA lines
When combining the SMA line:
- When the SMA 30 crosses the SMA 100 and the RSI crosses the 50 threshold, it could be a signal to buy.
- Conversely, when the SMA 30 crosses the SMA 100 and the RSI is below the 30 threshold, it may be a signal to sell.
However, to make accurate trading decisions, it is necessary to combine RSI and SMA with other factors and consider them carefully.
Combine RSI with Bollinger Bands indicator
Bollinger Bands is an indicator created from a moving average (MA) and price standard deviation. It is used to measure the volatility of product prices. When combining it with the Bollinger Bands indicator:
- When the price reaches the lower band of the Bollinger Bands and the RSI falls into the oversold zone, it may be a buy signal.
- Conversely, when the price reaches the upper band level of Bollinger Bands RSI falls into the overbought zone. This is a sign to sell.
The combination of the two indicators RSI and Bollinger Bands provides a clearer signal filter. It is capable of achieving a higher success rate in trading.
Apply the RSI indicator with the Failure Swing method
The Failure Swing method is when investors use RSI to decide to trade when it enters the overbought or oversold zone.
First, wait for RSI to enter the overbought or oversold limit zone. Next, continue to observe until RSI breaks out of this limit zone. Then, wait until RSI breaks the previous high or low to make a trading decision.
Combining reversal patterns
The method of combining reversal patterns emphasizes the use of the RSI index in combination with observing candlestick reversal patterns on the chart. When RSI reaches the overbought or oversold area. At the same time, a reversal candlestick pattern will appear. This can give a signal to investors to open trading orders.
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How to use the RSI to identify price trends
How to use RSI in identifying price trends, especially in Scalping Strategy Forex can be described as follows:
In-depth RSI indicates overbought and oversold levels
The RSI index provides information about overbought and oversold conditions of a stock. When RSI crosses the reference level of 70. This is a sign of an overbought market, implying that the price may decline. Conversely, when the RSI falls below the reference level of 30, it is a sign of an oversold market, suggesting that the price may increase.
In an uptrend, the RSI typically remains above 30 and often touches 70. While in a downtrend, the RSI rarely crosses above 70 and is often at 30 or below.
However, these assumptions need to be carefully considered. Often used in conjunction with other indicators to identify market trends and potential reversal points.
For example, if the RSI fails to reach 70 for several swings in an uptrend. A subsequent drop below 30, could imply that the trend has weakened and could reverse to the downside.
Conversely, if in a downtrend, RSI does not fall below 30. It then recovers to above 70, which could imply that the downtrend has weakened. From there, it can reverse into an uptrend.
Identify RSI divergence
Identifying divergences is another intended use of the RSI. When the RSI moves in one direction, but the price moves in the opposite direction. This shows that the current price trend is weakening and may soon reverse.
Bullish divergence occurs when RSI indicates an oversold condition. The higher low of the RSI then matches the corresponding lower low of the price. A bearish divergence occurs when RSI signals overbought conditions. The lower high of the RSI then matches the corresponding higher high in the price.
Although divergence is a valid signal, it rarely occurs when a stock is in a steady long-term trend. Therefore, flexibly applying the way to read overbought or oversold indicators will help identify more potential signals.
Determine the Swing Rejections point
Identifying swing rejections is another signal that the RSI can provide. This is when RSI returns from the overbought or oversold zone. This signal includes 4 steps as follows:
- RSI falls into the oversold zone.
- RSI crossed back above the 30 level.
- The RSI indicator dropped from its peak to a new low but it did not return to the oversold zone.
- RSI will then rise to break the recent peak.
The bearish “volatility rejection” signal also involves the same 4 steps:
- The RSI technical index will increase and enter the overbought zone.
- RSI dropped below the 70 level.
- RSI rose from the bottom to a new high but did not return to the overbought zone.
- RSI will then decline to break the nearest low.
Conclude
Above is all the important information about the RSI index that Forex Trading wants to share with readers. Hopefully, this knowledge will help investors better understand and apply the RSI indicator effectively in their investment process.
Frequently asked questions
What is the main function of RSI?
RSI is used to determine whether an asset is overbought. Or is it oversold in the market?
How is RSI used in technical analysis?
In technical analysis, RSI is often used to measure the overbought or oversold level of an asset.
How does RSI give buy and sell signals?
When the RSI crosses 70, it is an overbought signal and may be time to sell. Conversely, when RSI is below 30, it is an oversold signal and may be the time to buy.
