For financial investors, understanding indicators is important. RSI is one of them, a type of lagging indicator (following price) that many investors often use. So what is RSI index? What are its meanings and limitations? Let’s explore Forex Trading in this article!
What is the trader’s assessment of the RSI index?
The RSI (Relative Strength Index) is a popular technical analysis tool. Used by traders to evaluate the overbought and oversold levels of an asset. It measures the speed and extent of an asset’s price fluctuations over a certain period of time. According to traders, the RSI index will have the following advantages and disadvantages:
Advantage
- Easy to use and understand: RSI is calculated and displayed relatively simply, helping traders easily grasp information.
- Applicable to many markets: RSI can be used for many different asset classes such as stocks, currencies, commodities, etc.
- Fast response indicator: RSI has high sensitivity, helping traders recognize potential signals quickly.
- Can be combined with other indicators: RSI can be used in combination with other technical indicators such as the stochastic indicator to increase analysis efficiency.
Defect
RSI is a convenient and popular tool, simple to use. However, like any other indicator, RSI also has its own disadvantages.
- Using oversold (below 30 points) and overbought (above 70 points) zones to determine buy and sell points can lead to erroneous decisions. For example, in an uptrend, RSI crosses the 70 zone and declines. However, the stock price continues to rise, breaking new highs, while RSI remains above 70.
- Conversely, in a downtrend, RSI below 30 points can form a bottom and increase. But the price could still continue to fall and the RSI continues below 30 points.
- Similar techniques are only accurate in the short term. Therefore, investors need to combine RSI with other indicators to get better results.
See more: Be more successful through this technical analysis
Overview information about RSI indicator
Understanding RSI is key to effectively exploiting its potential. In determining buy and sell points, optimize profits and limit risks. Below is an overview of RSI you need to know before trading.
What is the concept of the RSI index?
The RSI indicator is a momentum-measuring tool used to analyze the next trend of a stock. It is represented as a line that fluctuates from 0 to 100. Areas below 30 points are considered oversold and areas above 70 points are overbought. When RSI is in the oversold zone, the stock may trend up. And when in overbought territory, the stock may tend to decline. To better understand how to use and apply the RSI indicator, learn more through this article.
What is the formula to calculate RSI?
RSI is an indicator calculated in two steps:
- First, we calculate the relative strength index by dividing the average rate of profit during the day by the average rate of profit loss during a period.
- Once we have the relative strength index, we use the following formula to calculate the current RSI:
RSI = 100 – 100/(1+RS)
Usually, RSI will be calculated over a 14-day period. This means using data from the previous 14 days to calculate RSI. But investors can adjust the RSI cycle depending on their level of understanding and analysis.
For example: In the last 14 days, the market has recorded positive closing results with an average increase of 1% over 7 days. While the remaining 7 days closed with an average decrease of -0.8%. Using the RSI formula, we can calculate:
RSI = 100 – 100/(1+ (1%/14)/(0.8%/14)) = 55.55
Why is it necessary to determine what the RSI line is?
The RSI index plays an important role for investors. Help them determine the right time to open or close a trade. Here are some reasons why it is important to determine the exact RSI line:
RSI indicator divides overbought and oversold zones
When the RSI exceeds 70, it is considered overbought. Indicates that the price has reached its peak and is likely to decrease.
Conversely, when RSI is below 30, it is considered oversold. Indicates that the price may be about to bottom and is likely to increase again.
What is the application to predict the increasing/decreasing trend of the RSI index?
If the RSI crosses 50 from the bottom up or is between 45 and 55. Then it crosses 55, then the market will usually go up.
However, if the RSI crosses 50 from above or is between 45 and 55, then falls below 45, it is usually a downtrend.
The RSI identifies price divergence and convergence patterns
To recognize price divergence and convergence patterns, we connect price peaks together and price bottoms together. When these two points are far apart, we call it divergence, and the market may reverse. In this case, investors need to stop selling and get ready to buy.
If these two points move close to each other, we say it is converging. Contrary to divergence, when there is convergence, the price can reverse from decreasing to increasing. Investors should stop buying and get ready to sell.
See more: Optimize trading with IC Markets Exchange
What is the effective way to use the RSI indicator?
There are many ways to apply the RSI index effectively in financial trading, for example:
What is the Failure Swing method in the RSI indicator?
In this method, players only need to monitor RSI when it is in the overbought and oversold zones to decide on a trade.
We need to wait for RSI to enter the overbought or oversold zone, then wait until RSI breaks out of this zone. Watch for volatility and only open orders when the RSI crosses the previous high or low.
Use the RSI indicator to combine multiple time frames
Similar to the scalping XAUUSD trading strategy, this method helps us identify price trends on the daily chart that have reached overbought or oversold levels.
- When the RSI < 30, the market is oversold, predicting a reversal from decrease to increase. So investors should buy.
- On the contrary, when RSI > 70, the market is overbought and is expected to reverse from increase to decrease. Therefore, investors should sell.
Determine the entry point on the 4-hour chart (H4), and wait for the price to enter the oversold zone on H4 to buy. And when the price enters the overbought zone on H4, sell.
What is the method of combining the SMA line with the RSI index?
When the 30-day moving average crosses above the 100-day moving average. And the relative strength index crosses the 50 level, which is a buy signal.
When the 30-day moving average crosses below the 100-day moving average. And the relative strength index is below 30, which is when it’s time to exit the buy signal.
When the 30-day moving average crosses below the 100-day moving average. Or the relative strength index is below 50, which is a sell signal.
When the 30-day moving average crosses above the 100-day moving average. Or the relative strength index rises above 70, which is the time to exit the sell signal.
Use the RSI indicator in combination with the Bollinger Bands indicator
Bollinger Bands are made up of moving averages and benchmark price volatility. Often seen as a price-lagging indicator.
When the price reaches the lower line of the band, RSI usually shows an oversold condition. When the price approaches the upper line of the tape, RSI often indicates an overbought condition.
Combining these two indicators creates a more powerful signal filter, with a higher likelihood of success.
Use the RSI divergence indicator
RSI divergence signals help investors identify points where the trend will change direction.
- When RSI falls but the stock price rises, this is a sign of negative divergence. It could be a sign of a bearish reversal of the stock.
- Conversely, when RSI increases but the stock price decreases, this is a sign of positive divergence. Be a sign of a bullish reversal of the stock.
Conclude
Above is all the important information that Forex Trading has provided about what is rsi index. Hopefully, this knowledge will help investors better understand and apply the RSI indicator effectively in their investment activities.
Frequently asked questions
What is the operating principle of the RSI index?
The RSI compares the average increase and average decrease in the price of an asset over a given period of time. Thereby determining the strength of the trend.
Can the RSI measure risk?
The RSI does not directly measure risk. However, it provides useful information for investors to evaluate the strength of the trend and the risk of being overbought or oversold.
Are there variations of the RSI?
Yes, there are many variations of the RSI developed to suit the needs and trading styles of different investors. Such as corrective RSI, time-based RSI, and combined RSI with other indicators.
