The RSI (Relative Strength Index)
The RSI is a strength indicator that varies between 0 and 100. It allows you to see oversold or overbought zones by calculating the relationship between growth averages and falling averages over a specific period.
Over a calculation period, if the currency pair has only experienced growth, the RSI will tend toward 100. On the other hand, if the market has only experienced drops, its value will be close to 0. When growth and shrinking forces tend to be neutral, its value will be close to 50.
The most often used observation period is 14 days, a shorter period will generate a high number of false signals.
Also, many technical analysis experts will recommend that you combine the RSI indicator with Bollinger Bands.
Use of the RSI
- Identifying overbought and oversold zones
If the RSI is 70 or higher, the currency pair is considered to be overbought (85 is a strong sell signal).
If the RSI is 30 or lower, the currency pair is considered to be oversold (15 is a strong buy signal).
These signals can be trustworthy in a market without any definite tendency and over shorter periods. If the market is in an upward trend, it is recommended that you use buying signals when the RSI is lower than 30 and do the opposite when the market is heading downward.
If the RSI period is shorter than 14, the overbought zone will start close to 80 and the oversold zone will start close to 20.
If the RSI period is greater than 14, the overbought zone will start close to 65 and the oversold zone will start close to 35.
- Identifying divergences and market swings
The RSI allows you to look for divergences in tension zones, marking possible exhaustion or even an inversion in the market's direction.
