Talking Points

-The Purpose of Oscillators like RSI

-When Traders Have a Hard Time Trading With RSI

-How to Use RSI in Extended Moves

When new traders come into the Foreign Exchange Market, they often look for a simple to indicator to use. Some like to turn to moving averages to identify trends. whereas others like to see when markets are hot and cold with the use of an oscillator. One of the most popular oscillators is the RSI.

The Purpose of Oscillators like RSI

T he Relative Strength Index (RSI) is probably the most commonly known and used technical oscillato r as it can identify when a market is overbought or oversold as told by the oscillators extreme ranges. As an oscillator, RSI is plotted with values between 0 and 100. The value of 70- 100 is considered overbought and a reversal to the downside is likely whereas the value of 30- 0 is considered oversold and a reversal to the upside is to be expected in a range.

Learn Forex: In a Clean Range, the RSI Is Hard to Beat

Presented by FXCMs Marketscope Charts

The rules above work best in a range bound market like USDJPY during the early half of 2014, the RSI extremes worked well for the buy low, sell high crowd.

Looking at the chart above, youd be in line to think that the RSI looks like an ideal tool for FX Traders. To some degree, the RSI is a great tool but to see the RSI only as a buy low, sell high tool can be difficult when markets break out when the tradition rules are applied however, a game plan that is too simplistic can do more harm than good. Too simplistic means that the traditional measure of buy when below 30 or breaking above 30 and sell when above 70 or breaking below 70.

When Traders Have a Hard Time Trading With RSI

Sometimes, markets break out into a strong trend. In fact, according to Elliott Wave. the first breakout is usually just the beginning of multiple moves higher with the potential of an extended leg of the uptrend. As you can imagine, if the market has broken out higher, then a selling an overbought market is very dangerous. This is especially true if you do not manage your risk on a trade.

If youre uncomfortable with the concept of Trade Management so that you dont let one trade sidetrack your trading goals you can register for our FREE online course here.

Learn Forex: When the Range Broke, RSI Remain Extreme Lacking Traditional Signals

Presented by FXCMs Marketscope Charts

A new trader who has learned about RSI would likely be very frustrated after the last year of price action on the USDOLLAR index. The prior 7 months before the chart shows consistent overbought readings while USDOLLAR traded up for all of 2013 until July 2013 when in turned south harshly. If you recognized the downtrend and then waited for a break above 70 to sell USDOLLAR, you never got the opportunity until 13 months later when USDOLLAR flashed an overbought signal and has since gone parabolic.

How to Use RSI in Extended Moves

When you find a strong trend unfolding, its best to adjust how you use RSI. A helpful way to adjust your use of RSI is to change what you define as oversold and overbought. In a strong uptrend, oversold may be as little as 40-50 range and in a strong downtrend, overbought and therefore an opportunity to sell or load into a trade may be as low as 50-60 before the downtrend resumes.

Learn Forex: XAUUSD Multi-Year Downtrend Has Given Few Signals with Traditional Readings

Presented by FXCMs Marketscope Charts

The highlighted circles show signals to sell based on lowering your overbought qualification. When youve done this, you can place your stop a few ATR above your entry or the prior swing high if less than that level. The examples shown above are on daily charts but you can use this adjusted range to increase your RSI effectiveness in strong trends on intraday charts as well.

See Also:

Happy Trading!

—Written by Tyler Yell, Trading Instructor