Relative Strength Index (RSI) – What It Is & How to Trade with It

Relative Strength Index (RSI) – What It Is & How to Trade with It

What is the Relative Strength Index (RSI)?

The Relative Strength Index (RSI) is a momentum-based indicator developed by J. Welles Wilder to measure the speed and change of price movements. It ranges between 0 and 100, identifying overbought and oversold conditions.

The RSI is calculated using the following formula:
RSI = 100 – [100 / (1 + RS)]

Where:

• RS (Relative Strength) = Average gain over n periods / Average loss over n periods
• n = Commonly set to 14 periods by default.

Key Features of RSI

• Identifies overbought (above 70) and oversold (below 30) conditions.
• Helps traders spot trend reversals and momentum shifts.
• Can be used for divergence trading and trend confirmation.

How to Use RSI in Forex Trading

1. Overbought & Oversold Strategy

Traders use RSI levels to identify potential reversal points:

• Buy Signal: When RSI drops below 30 (oversold) and starts moving upward.
• Sell Signal: When RSI rises above 70 (overbought) and starts moving downward.

Trading Tip: RSI works best in ranging markets where price oscillates between support and resistance.

2. RSI Divergence Strategy

Divergence between price and RSI can indicate a potential reversal:

• Bullish Divergence: Price forms a lower low, but RSI forms a higher low (buy signal).
• Bearish Divergence: Price forms a higher high, but RSI forms a lower high (sell signal).

3. RSI Trend Confirmation Strategy

Traders use 50 RSI level to confirm trend direction:

• Above 50: Bullish trend.
• Below 50: Bearish trend.

4. RSI with Moving Averages

Pairing RSI with moving averages (e.g., 50 EMA) can refine trade signals:

• Buy when: RSI crosses above 50 & price is above the 50 EMA.
• Sell when: RSI crosses below 50 & price is below the 50 EMA.

Pros and Cons of Using RSI

✅ Pros:

• Easy to use and interpret.
• Effective for spotting trend reversals.
• Works well in combination with other indicators.

❌ Cons:

• Can give false signals in strong trends.
• Less effective in highly volatile markets.

Final Thoughts

The Relative Strength Index (RSI) is a powerful momentum indicator that helps traders identify overbought/oversold conditions, trend reversals, and momentum shifts. When combined with other technical tools, RSI enhances trade accuracy and decision-making.