Trading - RSI indicator

What is the RSI?

The Relative Strength Index (RSI) is an oscillator that varies between 0 and 100 and measures the speed and magnitude of price movements. In general, an RSI above 70 indicates that the asset is overbought (potentially a bearish correction), while an RSI below 30 suggests that the asset is oversold (potentially a bullish rebound).

How is the RSI calculated?

ROI calculation is based on a mathematical formula that compares average gains to average losses over a given period, usually 14 periods.

1. Calculating average gains and losses :

   • Average earnings = Sum of earnings over 14 periods / 14
   • Average loss = Sum of losses over 14 periods / 14

2. RSI calculation :

   • RSI = 100 - (100 / (1 + RS))
   • Where RS (Relative Strength) is the ratio of average gains to average losses:
   • RS = Average gain / Average loss

RSI interpretation

The RSI is a useful indicator for identifying overbought and oversold conditions, as well as for detecting trend reversal signals.

1. Overpurchase and Oversale :

   • Overbought : An RSI above 70 indicates that the asset may be overbought, suggesting a possible downward correction. This means that the buyer has probably already taken a large share of the market, and a pause or reversal could be imminent.
   • Out of stock : An RSI below 30 means the asset is potentially oversold, and an upward rally could be on the cards. Investors could interpret this as a buying opportunity.

2. Divergences :

   • Bullish Divergence : When the price forms lower lows, but the RSI forms higher lows, this may indicate that selling pressure is easing, and an upward reversal could occur.
   • Divergence Baissière : When the price forms higher highs, but the RSI forms lower lows, this may suggest that buying pressure is waning and a decline may be imminent.

3. Overbought and oversold Extrema signals :

   • An RSI well above 70 (e.g. 80 or more) or well below 30 (e.g. 20) can signal that the market is in an extreme zone and that sharp reversals are possible.

Practical example

Suppose you analyze the EUR/USD chart with a 14-period RSI. Here's how you might interpret the signals:

1. Overbought :

   • The RSI is above 70, indicating that EUR/USD could be overbought. You may want to consider selling or taking profits, especially if the price starts to show signs of slowing or reversing.

2. Out of stock :

   • The RSI is falling below 30, indicating that EUR/USD could be oversold. This could be a good time to buy, in anticipation of a bullish price rebound.

3. Bullish Divergence :

   • Price is forming lower lows while the RSI is forming higher lows. This could indicate that selling pressure is easing, and a recovery could be just around the corner.

4. Divergence Baissière :

   • Price forms higher highs, but RSI forms lower highs. This may signal that buying pressure is waning, which could precede a price correction or decline.

Using RSI in Trading

The RSI is a powerful indicator for making trading decisions. Here are a few ways to use the RSI in your strategies:

1. Identifying overbought and oversold areas:

   • Watch for extreme RSI levels (above 70 or below 30) to anticipate a market reversal.

2. Confirming trends :

   • If the RSI remains above 50 in an uptrend, or below 50 in a downtrend, this may confirm that the trend is strong and ongoing.

3. Combine with other Indicators :

   • Use the RSI in conjunction with other technical indicators, such as moving averages or Bollinger Bands, to confirm or refine your trading signals.

4. Checking for discrepancies :

   • Watch for divergences between the RSI and price movements to anticipate trend reversals.

Conclusion

The RSI is an essential indicator for assessing the strength of price movements and identifying buying and selling opportunities. Understanding its calculation and knowing how to interpret its signals will enable you to make more informed decisions and improve your trading strategies.

We hope this article has helped you better understand the RSI. If you have any questions or would like to share your experiences, don't hesitate to join us on social networks with the hashtag #xenesy and identifying @xenesy_project. Happy trading!