Introduction – What’s the Relative Strength Index Indicator?
The RSI or Relative Strength Index Indicator is classified as a momentum indicator and was invented by J. Welles Wilder. The Relative Strength Index is used to measure the how fast price changes and by what measure this price change occurs.
What Makes Up the RSI (Relative Strength Index) Indicator?
The various components of the Relative Strength Index are smoothed out into a single line on the indicator window of the MT4 charts. However, there are several indicator components and due to the calibration of the RSI indicator window, there is an overbought zone as well as an oversold area.
The RSI is usually expressed in terms of a percentage and once the average gain exceeds the average loss, we will see higher RSI values. When the average loss exceeds the average gain, the RSI is seen to be lower. It is the RSI calculation which is represented as the single line in the indicator window.
The RSI indicator is found on the AG Markets MT4 platform as an Oscillator. Click “Insert”, then “Indicators” and on the drop-down menu, click on “Oscillators” and finally on “Relative Strength Index”.
Usage of the RSI in Forex Trading
The RSI indicator window is starts from 0 and ends at 100. When the RSI line is at a value >70, the market is said to be overbought and when it is at an area less than 30, then the market is oversold.
The RSI indicator can be used in several ways.
The RSI finds its most reliable use when it used in divergence trade setups. The RSI indicator line forms highs and lows that usually correspond to that of the price action. When there is a divergence situation, there is a trade opportunity. Divergence is seen when the RSI forms lower highs when price is forming higher highs, or when the RSI forms higher lows with price making lower lows. A trend line is traced on the highs and lows of the price as well as the RSI to make this divergence scenario a lot clearer. Once the divergence is observed, a technical basis for trade entry must be sought and used to enter any trades. We see an example of an RSI divergence trade below.
Here the RSI is seen forming higher lows while the price action is forming lower lows. A technical entry parameter is seen in the form of a bullish engulfing triangle pattern, which provides the impetus for the trader to make a long trade entry.
The RSI can also be used in trend trading. Here, the 50 mark is taken as the benchmark, with 40 as the lower border and 60 as the upper border of price range. RSI may bobble between 40 and 60 for a long time. A break of 40 or 60 will lead price to push to new lows or new highs respectively, before overbought/oversold regions are attained.