Basic Finance Care Finance tips
Have you heard other forex traders using the term RSI and wondered what they were talking about? If so, your curiosity can pay off if you learn not only what the RSI indicator is but how to use it effectively in your day-to-day transactions. Truth be told, this handy math-based formula is a powerful tool for traders of all types, not just those who buy and sell currency pairs. You can look up a definition and learn that the letters stand for relative strength index, but if you want to dig into the mathematics behind the formula, you might come away even more confused. The quickest way to acquire an understanding of how to actually use it in your own trading is to look at four key facts below.
It Measures Momentum
The first point to absorb is that the relative strength indicator is mathematically designed to measure price momentum. It’s obvious that the prices of almost every currency pair rise and fall constantly, but wouldn’t it be nice to know how strong those rising and falling tides are? That’s what RSI measures, and it does it with a factor between 0 and 100.
An Example of the 70/30 Rule
A real-world example is to suppose you look at a chart for ABC Corp. share prices, or the current price of your favorite forex pair. You can enable the RSI indicator on the chart to see the relative strength values underneath the main chart. If the current RSI factor is above 70, the market is said to be over-sold, or getting ready to drop. A value below 30 reveals a market that is over-bought, or about to experience a rise in prices.
The Nuance of the 70/30 Rule
Here’s the nuance of the above rule, and you can test it out for yourself on pricing charts for stocks, precious metals, or currency pairs in forex trading with brokers like easy Markets. An RSI above 70 means there is strong momentum that is about to peter out. But, when will that be? Likewise, a value below 30 means prices are set to rise soon, but how soon?
You can usually get a clear answer to those two questions of timing by waiting for the RSI line to puncture the 30 or 70 threshold and enter the middle zone of the chart. For instance, let’s say you’re observing XYZ Corporation’s chart and notice that the relative strength line has been above 70 for several weeks, indicating that prices are getting ready to fall. Many traders won’t sell until the factor breaks below the 70 mark and begins to travel downward. That’s the nuance of knowing how to use this indicator for sell and buy signals. Note that a buy signal would be when the indicator is below 30 for a while and ten breaks through and above 30, headed upward.
RSI is Best Used with Other Indicators
If you combine other data with relative strength, you can get confirmation of trend direction much more easily. Typically, people use relative strength with moving averages or any of a dozen or so other indicators to gain a clearer picture of price behavior.
