The relative strength index or the RSI is a momentum oscillator used to measure the velocity and magnitude of directional price movements. The indicator provides the investors with sell or buy signals when the asset is overbought or oversold respectively.
The RSI changes from 0 to 100% and can be presented by a single fluctuating line. The closer this line gets to the zero mark the higher are the chances that the asset is oversold. The price, in this case, can be expected to go up. When the RSI gets close to 100%, the asset is likely to be overbought. According to the indicator, the asset price will, therefore, fall soon.
About the author
The indicator was developed and introduced into practice by an American engineer J. Welles Wilder, real estate developer and famous technical analyst.
In 1978 it appeared in author’s bestselling New Concepts in Technical Trading Systems and June issue of Commodities magazine (now Futures magazine). It has become one of the most popular oscillator indices and is now considered to be a core indicator in the technical analysis software.
How to use RSI indicator in trading?
As noted above, the RSI oscillates between 0 and 100%. Traditionally the RSI is considered overbought when above 70% and oversold when below 30%. If the indicator provides a lot of false alarms it is possible to increase the overbought threshold to 80 and decrease the oversold threshold to 20.
J. Welles Wilder recommended a smoothing period of 14, which of course can be changed for the purposes of short- and long-term strategy adaptability. Shorter or longer periods are used for alternately shorter or longer outlooks.
The RSI is a universal indicator and can be used for the purpose of trading any assets from indexes to currency pairs and derivatives.
Note that during strong trends the RSI can remain in the oversold/overbought zones for quite a long time!
RSI Settings and Configurations
In order to use the relative strength index in IQ Option trading platform, click on the “Indicators” button in the lower left corner of the screen. Choose “RSI” from the list of possible indicators.
Then simply click the “Apply” button if you prefer standard settings. The RSI graph will appear in the bottom part of your screen.
Expert traders may find useful taking one more additional step and going to the “Set up & Apply” tab.
Choose the RSI settings: the period of your liking, as well as overbought and oversold levels for more sensitivity/accuracy. Remember that the wider the corridor the fewer signals you get, but at the same time they will be more accurate. The opposite is the case if the threshold levels are closer to each other: the crossover signals will appear more often, but the number of false alarms will also increase. Remember that by increasing the “Period” parameter you are making the indicator less sensitive.
Standard approach – 70/30
The smoothing period of 14, oversold level 30% and overbought level 70% are used in the standard approach. This is the most frequently used preset for this indicator. Traders expect the RSI to bounce from 30 and 70 threshold lines. With standard parameters it will happen quite often, but it won’t always mean the actual change in the trend direction is coming.
Conservative approach – 80/20
The smoothing period of 21, oversold level 20% and overbought level 80% are advised by the conservative approach advocates. Risk-averse investors set up the indicator in a way that will make the RSI less sensitive and therefore minimise the number of incorrect signals. More extreme high and low levels — 90 and 10 — occur less frequently but indicate stronger momentum.
Divergence is another way to use the above-mentioned indicator. If the movement of the underlying prices is not confirmed by the RSI it can signal a trend shift.
Divergence can be a good indicator of a coming price reversal. In the example above the price of the asset goes down, while the RSI demonstrates the opposite movement. This situation is followed by the trend shift.
The RSI is a powerful tool that can tell traders when to buy and when to sell. Sometimes it can also predict the trend other indicators are too slow to acknowledge. However, it is rarely used on its own and is recommended to be combined with other indicators. The RSI can be combined with other indicators for increased accuracy and efficiency.Try now
NOTE: This article is not an investment advice. Any references to historical price movements or levels is informational and based on external analysis and we do not warranty that any such movements or levels are likely to reoccur in the future.
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