The relative strength index(RSI) is usually used to detect when a market is overbought and oversold. The RSI can be used to develop an intraday forex trading strategy that capitalizes on evidence that a market is overextended and therefore likely to retrace.
The RSI is a commonly used technical indicator that identifies overbought conditions when the RSI value exceeds 70 and oversold conditions when the RSI value falls below 30. The more extreme readings of 80 and 20 are preferred by some traders and experts. The RSI’s drawback is that fast, sharp price fluctuations can cause it to jump up and down repeatedly, making it vulnerable to misleading warnings. When compared to other signals, such spikes or dips that indicate a trade confirmation could signal an entrance or exit point.
In this article, we’ll be looking at how to use RSI in Forex.
Trading Setups Using RSI
If the market is overbought or oversold, it is common for the price to extend considerably further than the point at which the RSI signals it first. In order to avoid executing a trade too soon, a trading strategy based on the RSI performs best when paired with other technical indicators.
We’ve defined a few strategies for implementing an intraday forex trading strategy that incorporates the RSI and at least one other confirming indicator:
- Monitoring the RSI for readings which indicate if the market is overbought or oversold.
- Look for signs of an approaching retracement using other momentum or trend indicators. If the RSI indicates oversold readings, a retracement to the upward is much expected but it is not guaranteed to be happening accordingly.
If one of these additional conditions is are met, it is considered good practice to consider entering a trade hoping to profit on a retracement:
- The MACD (Moving Average Convergence Divergence) has shown price divergence
- The average directional index (ADX) has shifted towards a probable retracement.
If the above conditions are met, consider starting the trade with a stop-loss order just beyond the most recent low or high price, depending on whether the trade is a buy or sell trade. The nearest identified support/resistance level might be used as the initial profit target.