22.How to Trade the Relative Strength Index (RSI) Like a Pro

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  • Added: 17-Dec-07

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A lesson on how to trade the RSI for traders and investors using technical analysis in the stock market, futures market and forex market.

In our last lesson we looked at 3 different ways that the MACD indicator can be traded. In today's lesson we are going to look at a class of indicators which are known as Oscillators with a look at how to trade one of the more popular Oscillators the Relative Strength Index (RSI).

An oscillator is a leading technical indicator which fluctuates above and below a center line and normally has upper and lower bands which indicate overbought and oversold conditions in the market (an exception to this would be the MACD which is an Oscillator as well). One of the most popular Oscillators outside of the MACD which we have already gone over is the Relative Strength Index (RSI) which is where we will start our discussion.

The RSI is best described as an indicator which represents the momentum in a particular financial instrument as well as when it is reaching extreme levels to the upside (referred to as overbought) or downside (referred to as oversold) and is therefore due for a reversal. The indicator accomplishes this through a formula which compares the size of recent gains for a particular financial instrument to the size of recent losses, the results of which are plotted as a line which fluctuates between 0 and 100. Bands are then placed at 70 which is considered an extreme level to the upside, and 30 which is considered an extreme level to the downside.

Example of the RSI


The first and most popular way that traders use the RSI is to identify and potentially trade overbought and oversold areas in the market. Because of the way the RSI is constructed a reading of 100 would indicate zero losses in the dataset that you are analyzing, and a reading of zero would indicate zero gains, both of which would be a very rare occurrence. As such James Wilder who developed the indicator chose the levels of 70 to identify overbought conditions and 30 to identify oversold conditions. When the RSI line trades above the 70 line this is seen by traders as a sign the market is becoming overextended to the upside. Conversely when the market trades below the 30 line this is seen by traders as a sign that the market is becoming over extended to the downside. As such traders will look for opportunities to go long when the RSI is below 30 and opportunities to go short when it is above 70. As with all indicators however this is best done when other parts of a trader's analysis line up with the indicator.

Example of RSI Showing Overbought and Oversold:

A second way that traders look to use the RSI is to look for divergences between the RSI and the financial instrument that they are analyzing, particularly when these divergences occur after overbought or oversold conditions in the market. These divergences can act as a sign that a move is loosing momentum and often occur before reversals in the market. As such traders will watch for divergences as a potential opportunity to trade a reversal in the stock, futures or forex markets or to enter in the direction of a trend on a pullback.

Example of RSI Divergence:

The third way that traders look to use the RSI is to identify bullish and bearish changes in the market by watching the RSI line for when it crosses above or below the center line. Although traders will not normally look to trade the crossover it can be used as confirmation for trades based on other methods.

Example of the RSI Centerline Crossover:


That's our lesson for today. You should now have a good understanding of the RSI and how traders use this indicator in their trading. In tomorrows lesson we will look at another Oscillator which is known as the Stochastic Oscillator so we hope to see you in that lesson.

As always if you have any questions please feel free to leave them in the comments section below, and have a great day!

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Comments on

22.How to Trade the Relative Strength Index (RSI) Like a Pro

26 Comments | Add Comment
  • newbie guide

    forex is stressing so learn as much as you can.if youre a beginner try these free online guides

    econtrader. com

    babypips. com

    these sites are really helpful and read stuff about economics too

    read more.. especially books like
    dummy guide to forex and of course economics books .
    and forget about the get rich quick scheme
    and having a conclusion on the state of the economy varies between one person to another
    control your impluses too. dont just trade coz it looked good at the moment.

    By frugal007 1220864889 Reply Spam Moderate Up Moderate Down
  • GREAT video for ...

    GREAT video for beginners! :D

    By toguNYC [Affiliate User] 1217667581 Reply Spam Moderate Up Moderate Down
  • Hi Magic, Thanks ...

    Hi Magic, Thanks for the comment and for watching I'm glad you like the videos. Best Regards, Dave

    By InformedTrades [Affiliate User] 1216058179 Reply Spam Moderate Up Moderate Down
  • Hi Dave, great ...

    Hi Dave,

    great job. Thx.

    Regards, magic

    By magicbroker [Affiliate User] 1215956660 Reply Spam Moderate Up Moderate Down
  • Thanks David, I ...

    Thanks David, I made some hand written notes on your comments.
    Thanks

    By Especially4Naasira [Affiliate User] 1208529934 Reply Spam Moderate Up Moderate Down
  • yes the RSI is the ...

    yes the RSI is the relative strength of an instrument compared to the past strength of the instrument which is why it is a momentum indicator. There is also a relative strength indicator which compares two different instruments so you are right they are often confused. In general and always with my videos if you see relative strength index they are talking about the indicator we are discussing here. Best Regards, Dave

    By InformedTrades [Affiliate User] 1208334248 Reply Spam Moderate Up Moderate Down
  • Hi ...

    Hi Especially4Naasira, Thanks for the comment.

    1. Yes RSI is designed in a way that I think most would call it a leading technical indicator.
    2. As far as the RSI and the Stochastic go they are derived in a way to show similar things so its really a matter of preference there amoung the specific traders. As the MACD uses moving averages however you have additional insight over and above momentum.

    2. Most would say yes and yes but more so when extreme.

    Best Regards, Dave

    By InformedTrades [Affiliate User] 1208334134 Reply Spam Moderate Up Moderate Down
  • (because ...

    (because conventional name RSI is misleading..)

    By Especially4Naasira [Affiliate User] 1208146154 Reply Spam Moderate Up Moderate Down
  • Something that may ...

    Something that may help you: I read somewhere that RSI was a relative strength of it's own market.

    So now, I use the RSI pseudo acromyn as:
    Relative Strength of Itself (may help your readers)

    By Especially4Naasira [Affiliate User] 1208146105 Reply Spam Moderate Up Moderate Down
  • Hello, I have been ...

    Hello, I have been studying the ROC momentum indicator.
    1) Since RSI is a momentum indicator, is it also a LEADING indicator (the ROC is)
    2) All the indicators seem to be similar in use, what is advantage of using RSI over STOCASTICS or MACD? They all seem to do the same thing, i.e. they warn of change in trend.
    3) Does the RSI divergence count if its not from extreme values? (Also does the stochastics divergence count if not from extreme values?)
    Thank-you very much David:)

    By Especially4Naasira [Affiliate User] 1208145688 Reply Spam Moderate Up Moderate Down
  • The middle line ...

    The middle line crossover in my opinion is the most effective, provided you use stop losses. Even looking in your charts, I can analyze that though sometimes "hiccups" do occur, but in that case the sensitivity of the indicator helps the user abort a trade and prevent further losses.

    By atlanticl [Affiliate User] 1207899536 Reply Spam Moderate Up Moderate Down
  • Great thanks Dave! ...

    Great thanks Dave! I dislike ambiguity and like things to be clear. Your help was much appreciated!

    By regikeyz [Affiliate User] 1206067615 Reply Spam Moderate Up Moderate Down
  • Hi Regikeyz, Some ...

    Hi Regikeyz,

    Some examples of indicators that are not oscillators are bollinger bands and moving averages.

    You are correct that volume is not an indicator as indicators are based off of volume and price. I wouldn't get too caught up in the semantics here though just remember that all these things can tell you things about the market and understanding what they tell you is really what matters. Best Regards, Dave

    By InformedTrades [Affiliate User] 1206035068 Reply Spam Moderate Up Moderate Down
  • Could you give some ...

    Could you give some examples of indicators that are not oscillators? Just so I can visualise the difference?

    Is plotting volume bars an indicator?
    I don't think so as it works directly on the immediate data (i.e. not derived from it).. where as OBV would be an indicator.. is this correct mate?! Many many thanks!

    By regikeyz [Affiliate User] 1206028216 Reply Spam Moderate Up Moderate Down
  • Hey excellent, ...

    Hey excellent, thank-you very much by your very quick response! That does clear things up for me significantly..

    Only question remaining is im just trying to think of an indicator that is NOT an oscillator..

    Every indicator I can think of is also an
    oscillator..

    Sentiment indicator is not an oscillator right?
    Also Bollinger bands are indicators but not oscillators? But they do kind of oscillate dont they..?!

    By regikeyz [Affiliate User] 1206028164 Reply Spam Moderate Up Moderate Down
  • Hi Regikeyz, No ...

    Hi Regikeyz, No problem. An oscillator is simply an indicator that fluctuates around a center point like the MACD, the Stochastic, and the RSI. So yes all oscillators when referring to trading are also indicators.

    An indicator is simply a mathematical formula applied to pieces of data on a chart which tries to tell you something about the market such as whether it is trending or in a range. Hope that helps and Best Regards, Dave

    By InformedTrades [Affiliate User] 1205930978 Reply Spam Moderate Up Moderate Down
  • Hi David, I'm ...

    Hi David, I'm confused as to the difference in definition between an OSCILLATOR and an INDICATOR

    1) Are all oscillators also Indicators?
    e.g. MACD I thought was an indicator

    2) What is definition of oscillator and what is def of indicator?

    Any help would be much appreciated!

    By regikeyz [Affiliate User] 1205860926 Reply Spam Moderate Up Moderate Down
  • hai i am ...

    hai i am devilroshan from Brunei after watching ur video i mnage double my 100USD mini account become 500USD...thanks for your RSI how about any technique can you share me another technique?

    By devilroshan [Affiliate User] 1205717302 Reply Spam Moderate Up Moderate Down
  • Hi HGalland, ...

    Hi HGalland, Thanks for the comment am glad you are enjoying the videos. Best Regards, Dave

    By InformedTrades [Affiliate User] 1202637742 Reply Spam Moderate Up Moderate Down
  • Hello David, Just ...

    Hello David,

    Just made it to Lesson 22 and again outstanding. I appreciate the quality of this work and the professionalism on making this concepts and examples available to everyone.

    Thanks again.

    By HGalland [Affiliate User] 1202609542 Reply Spam Moderate Up Moderate Down
  • hi cableforex, ...

    hi cableforex, thanks a lot for the feedback. Once I am done with the basics I will let you know. Best Regards, Dave

    By InformedTrades [Affiliate User] 1198168759 Reply Spam Moderate Up Moderate Down
  • Great entry level ...

    Great entry level explanation of the RSI. Look forwad to an explanation that pitches to an advanced level.

    By cableforex [Affiliate User] 1198168122 Reply Spam Moderate Up Moderate Down
  • thanks a lot for ...

    thanks a lot for the feedback. Will add that to the list and let you know when it is up. Best Regards, David

    By InformedTrades [Affiliate User] 1197975110 Reply Spam Moderate Up Moderate Down
  • Very good. At some ...

    Very good. At some point please do an "advanced" version where more suttle uses of the RSI are demonstrated, such as an RSI trendline break. Well done and appreciated.

    By Schweizer135 [Affiliate User] 1197946880 Reply Spam Moderate Up Moderate Down
  • Thanks a lot for ...

    Thanks a lot for the feedback I am glad you liked it. Best Regards, David

    By InformedTrades [Affiliate User] 1197930825 Reply Spam Moderate Up Moderate Down
  • ...and to think of ...

    ...and to think of what other are charging for this same info. Thanks David, much appreciated.

    By jeffguroo [Affiliate User] 1197927583 Reply Spam Moderate Up Moderate Down
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