Forex and Futures: RSI signal, Relative Strenght Index

RSI is a popular indicator commonly used to confirm price movement and help identify turning points in the market. It was created by Welles Wilder Jr.

In general RSI is used either as an indicator of overbought or oversold market conditions in consolidating markets or to identify divergences at trend exhaustion.

The RSI is a price-following oscillator that ranges between 0 and 100. A popular method of analyzing the RSI is to look for a divergence in which the currency price is making a new high, but the RSI is failing to surpass its previous high. This divergence is an indication of an impending reversal. When the RSI then turns down and falls below its most recent trough, it is said to have completed a "failure swing." The failure swing is considered a confirmation of the impending reversal in the price of the currency.

RSI levels of 70% and 30% (80% and 20%) are known as overbought/oversold levels. Buy signal generated when the market is oversold, sell signal generated when the market is overbought. These levels are only working good inside range phase and produce losses during trend phase.

In a perfect world, every trader would be looking at a 14 day RSI and making trading decisions based on that. If that was the case, when RSI would go under the 30 level, everyone would buy and by consequence the price would rise. Needless to say, the world is not perfect and not all market participants follow the same technical indicators, draw the same trendlines and identify the same support & resistance levels.

Forex chart patterns have been recognized and categorized for over 100 years and the manner in which many patterns are repeated leads to the conclusion that human psychology changes little over time. Technical analysis is used to identify patterns of market behavior that have long been recognized as significant. For many given patterns there is a high probability that they will produce the expected results. Also, there are recognized patterns that repeat themselves on a consistent basis.

When Wilder introduced the RSI, he recommended using a 14-day RSI. Since then, the 9-day and 25-day RSIs have also gained popularity. Because you can vary the number of time periods in the RSI calculation, I suggest that you experiment to find the period that works best for you. (The fewer days used to calculate the RSI, the more volatile the indicator.). A popular method of analyzing the RSI is to look for a divergence in which the instrument (currency pair) is making a new high, but the RSI is failing to surpass its previous high. This divergence is an indication of an impending reversal.

The RSI shows, sometimes more clearly than price themselves, levels of support and resistance. Divergences occur when the price makes a new high (or low) that is not confirmed by a new high (or low) in the RSI. Prices usually correct and move in the direction of the RSI.

Dont forget to set your charts properly: Choose quiet colors. Establish the size and color of the text and any other element of the graph so that they strongly were not allocated. As much as possible allocate both RSI the indicator and MACD. Make their convenient for reading. They are the only thing, that we wish to allocate during trade. Any other information is not important. If something is allocated another besides patterns RSI you will be focused on it and worsen time of your reaction.

Simply selling when the RSI is above 70 or buying when the RSI is below 30 is not recommended. A move to those levels is a signal that the top or bottom may be a near but it certainly does not indicate a top or a bottom. For example, the market makes new lows after a bear market pullback, but the RSI fails to exceed its previous lows. Another example of divergence is when prices continue to move higher while the RSI fails to move higher during the same time period.

Market sentiment is what most of the market is perceived to be feeling about the market and therefore what it is doing or will do. This is basically about trend. You may have heard the term 'the trend is your friend', this basically means that if you're in the right direction with a strong trend you will make successful trades.

Traders however have a tendency to use a limited variety of technical tools. The most common are 9 and 14 day RSI, obvious trendlines and support levels, fibonnacci retracement, MACD and 9, 20 and 40 day exponential moving averages. The closer you get to what most traders are looking at, the more precise your estimations will be. The reason for this is simple arithmetic, larger numbers of buyers than sellers at a certain price will move the market up from that price and vice-versa.

Where price trends, RSI goes up the limits of its excursion, and bounces around there for an extended period of time, until the trend eventually reverses. RSI is a measure of investor sentiment, and as such is used to forecast shifts in trend. It is prescient in forecasting turns in the market.