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RSI Overview

RSI was positioned as a tool to determine the strength of a trend movement and the likelihood of a price reversal. Its purpose is described in its name. “Relative strength” is determined by comparing the current price value on the chart and its average value over a certain time interval in the past. Averaging parameters can vary, but the standard period is 25.

The interface of the oscillator

The RSI oscillator has 1 line plotted in a separate window under the chart. The curve moves in a manner that highly correlates with price behaviour on the chart. In addition, it smooths out short-term price fluctuations (about 20% of all movement on the chart). The oscillator window has a vertical 0-100 scale. The oversold zone is located at the bottom and the overbought zone at the top. A roughly neutral area is in the middle.

RSI Overview

Bu default, its boundaries are at 20 and 80. However, the oscillator curve relatively seldom goes that far from the neutral position. This is why, in practice, many traders have to manually change the range of boundaries to 25–75 or 30–70. This decision may be reasonable depending on the volatility of the selected trading asset. The RSI window can be split into two halves. To do this, both boundaries are fixed at 50, actually merging into one line as a result.

Market analysis using RSI

Oscillators are often used as a secondary price filter that enables you to adjust trading signals produced by other tools. However, a pro can use RSI as the only element of a strategy.

Signals of the Relative Strength Index:

  • rise or decline— shows the current strength of an up- or downtrend;
  • overbought— the chart price is too high, a downtrend is to be expected soon;
  • oversold— the opposite situation: the oscillator shows a price that is too low, usually followed by a period of rise in the chart;
  • divergence/convergence— divergence, when the price moves in one direction on the chart and the oscillator line is plotted in the opposite direction.

RSI Overview

Oversold and overbought are the main RSI signal. When entering these zones, the oscillator shows the exhaustion of the potential of the active trend. In this situation, traders usually expect the trend to reverse soon. The trading signal is the point where the oscillator curve exits from the overbought or oversold zone. At this moment, a trade would be reasonably made in the direction of the trend movement.

Besides, the Relative Strength Index can be used for visual graphical analysis. For this purpose, reversal patterns created by the line are analysed. The most common ones are “head and shoulders” and “double/triple top.” However, it should be remembered regardless of the strategy used that, in financial terms, online trading is a highly risky business.

 

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