How to Use RSI (Relative Strength Index) in Trading
Out of the many oscillators available for technical analysis, the relative strength index (RSI) remains the most preferred choice among traders of all levels. After reading this article, you should be able to define RSI, its related terms, and how to implement the RSI strategy like a seasoned trader.
The relative strength index, or RSI, was discovered by Welles Wilder, with the primary purpose of identifying extreme market conditions. RSI shows the overbought or oversold market zones; as a result, it remains a useful tool for making better trading decisions.
Traders use the RSI trading strategy to identify extremes, to confirm a trend, and also to identify divergence. In the oversold zone (when the RSI is below 30), selling pressure increases, and a technical correction is likely to occur. Prices are forming a bottom since there are no more sellers, hence prompting buyers to enter the trade. Prices eventually reverse. If the RSI indicator reverses upwards as well, then this is an excellent opportunity to buy.
In the overbought zone, RSI is above 70. When this happens, the implication is that the buying pressure has increased, and the price will form a top. Fewer buyers stay in the market, and sellers begin to enter the trade. A correction is likely; this will reverse the price downward. If the RSI reverse downward as well, this indicates an excellent opportunity to sell. It is important to note that once RSI goes above 70 levels, and the indicator comes out of the overbought zone crossing below the 70 levels, it is the right time to place a sell order.
One of the many functions of the RSI indicator strategy is in the confirmation of the trend of the market. You do this by drawing trendlines on the RSI indicator, if the RSI's trend line stays intact, it confirms that the trend holds well. RSI trend lines are particularly useful when trading on larger time frames.
So, when you see the MACD line crossing already, but the RSI is not hitting 70 yet, its probably beautiful to look for an entry long. Secondly, when you see your RSI starting to turn red, don't worry, check your MACD and see if the two lines are far-away from crossing. And if that is the case, don't worry about the trade, stay longer until the MACD confirms. The oversold RSI is there to remind you that there could be a trend change coming soon. By using the MACD RSI trading strategy, it allows you to see the potential upcoming trend changes early.
Two-period RSI pullback trading strategy
The RSI 2 is a 14 period, switched into a two-period. Here overbought level is greater than 90 (the higher, the better) while the oversold level is less than 10 (, the lower, the better). Long term traders may look at the 200 moving average. Using a two-period RSI, we could determine when a market pullback in prices far enough and may lead to a snapback in price. RSI overbought or oversold is an objective measure of pullbacks.
You can adopt this strategy to a short-term trading strategy by altering the time frame trading and the indicator settings that we are using for trend. The RSI is set to period 2, the oversold level is 10, and overbought is 90. Using a 34 exponential moving average (EMA). However, if you happen to be a short-term trader, you may consider using a 10-period moving average (MA). Experience traders will consider price structure. So, for a buy-setups, you price trading above the 34 EMA, or the average is sloping upwards. The 2-period RSI pulls back and drops below level 10. A price can play around the moving average but, strong momentum disqualifies the setup. We can use trend line breaks, candlestick reversal patterns, or price action for trade entry.
In sell setups, the price will be trading below the moving average/ or average is sloping downwards. The 2-period RSI pulls back and rises above 90-level. Price can play around the average. But, strong momentum disqualifies the setup again, trendline breaks, candlestick reversal patterns, or price action. A trader can use all of them for trade entry.
A Laguerre RSI strategy is a swing strategy that uses a unique custom indicator. It shows traders the periods of inactivity on the activity, with the primary purpose of defining bullish and bearish market entries. A Laguerre crossover power strategy is a simple buy/sell strategy that buys dips in uptrends and sells rallies in downtrends.
RSI divergence strategy – divergence suggests that current momentum is over; therefore, you should protect any current profits and prepare to trade in the opposite direction. RSI indicator is useful in helping a trader trade better by identifying the RSI divergence signal. Divergence is when the RSI indicator is not moving in the same direction as the movement of the market. This piece of useful information indicates an impending trend reversal; This allows a trader to enter the trade. The divergence could be bullish or bearish.
A bullish divergence takes place when the market is in a downtrend, and prices are making a new low. However, the relative strength index does not continue lower; instead, it begins to change direction to climb back up. This bullish signal indicating that the trend is about to change course to an uptrend allows traders to buy.
Bearish divergence, on the other hand, occurs when the market is in an uptrend, and prices are making a new high. On the other hand, the relative strength index does not continue higher; instead, it moves downward. This bearish signal indicating that the trend is about to reverse and becomes a downtrend that allows traders to sell.
Swing trading RSI
The most common mistake made by most traders is to trade every divergence signal that shows up on the chart. Traders need to avoid this trading move. To effectively use RSI for a swing trading strategy, the trader must note the following:
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Look for the precise structure of price trending.
- Daily time-frame is preferred.
- Target probability only between 30 – 35regions or below the 30-region RSI.
- The most recent low on price should be the stop loss.
- Don't risk more than 1% of the account till you master this strategy.
RSI settings for day trading
The default RSI trading setting is the 14 period; this is just fine for swing traders. However, many intraday traders are not comfortable with it; hence they resolve to lower their time-frame. Conversely, others reduce the RSI period setting to get a more sensitive oscillator.
Stochastic RSI trading system
Stochastics is a momentum oscillator that compares the closing levels of a high/low range of stock. Stoch RSI was developed by Tushard and Stanley Kroll to measure RSI to its range and applies stochastics to RSI instead of price values. The purpose is to correct defects in RSI concerning an overbought/oversold signal.
The problem with RSI is that it can oscillate between 80 and 20 for extended periods without diving into the overbought/oversold values of over 80 or less than 20. StochRSI generates more (and more accurate) signals. The StochRSI measures the worth of RSI relative to its high-low range over a certain number of periods. The number of periods used to calculate StochRSI is transferred to RSI in the formula.
- (RSI – Lowest low RSI) / (Highest high RSI- lowest low RSI)
- Stoch RSI is = 0 when RSI is at its lowest point.
- Stoch RSI = 1 when RSI is at its highest point.
- Stoch RSI = 0.5 when RSI is in the middle of its high-low range.
- Values of 0.8 and 0.2 are deemed significant./li>
When interpreting Stoch RSI, the first thing to consider is the duration of the time period under consideration, as this correlates to whether or not it could be viewed as a long term or short-term indicator. Using a 14-day time period, for example, will make stochRSI a short-term sign, using a 200-day time will make it a long-term. Stock with values of 0.8 or higher is considered overbought and due for a correction. In contrast, shares of 0.2 or lower are considered oversold and fitting for a rebound.
Conclusion
The RSI comes with a single line and two levels placed by default. Its plotting is on a separate window just as it is with every other oscillator.
There is more to RSI than signaling the point where the market is overbought and oversold. When used in the wrong way, RSI is useless for many traders. However, when traders combine the RSI with the right indicators, they'll be able to create a formidable trading system.
A trader shouldn't use the RSI as a trading signal without confirmation. During trending conditions, the RSI would offer excellent trading signals, and to smooth the signals of the RSI, you could add a moving average on the indicator. We highly recommend the use of stop-loss orders when trading with the RSI.
