Key Takeaways🔑
| →The RSI indicator is a powerful tool for identifying overbought and oversold conditions in the market. |
| →The RSI can help predict trend reversals, making it an essential tool in your trading strategy. |
| →Understanding the concept of divergence in the RSI can significantly enhance your market analysis. |
Contents
Overview of the RSI indicator
The RSI is an abbreviation from the Relative Strength Index. It is a momentum oscillator and it helps with the technical analysis in identifying the oversold and overbought areas of the asset. It shows the price movements and signals the reversal of the trend.
The RSI oscillates between two levels which are 0 and 100. But in the indicator’s window, you will see three lines of values 30, 50, and 70. 50 shows the middle. 30 and 70 are much more significant because they are shreds of evidence that a given asset is in the oversold or overbought zone. That is, when the RSI line drops below 30, it will mean the asset is oversold. In opposition, when the RSI exceeds 70, the asset will be recognized as overbought.
What the oversold and overbought areas mean? Well, if the asset falls into the oversold zone it signifies the dominance of the sellers on the market. If the asset is overbought, this would mean the buyers’ dominance.
How to set up the RSI on the Olymp Trade platform
The first step is to press the indicators feature button which is located in the bottom left corner of the chart. Then you will see all the indicators on your left. Scroll down to the oscillators. You will find the RSI among them. Now click on it and the indicator is set up.
You can choose to change some of the indicator’s parameters. To do so, click the pen icon in the oscillator window. Then you can adjust the period, the color, and the width of the line. The default period is set for 14. The period here is the time interval in which the RSI measures price changes. 14 indicates that the indicator gathers information about the price from 14 candles.
How to use the RSI indicator at Olymp Trade
The RSI range is between 0 and 100. Whenever it exceeds 30, the asset is considered to be oversold and soon the trend will reverse. The same happens on the other side. Whenever the RSI crosses 70 and goes beyond, the asset is considered to be overbought and the trend reversal is imminent.
The big question is how to use this knowledge to your advantage. Let’s look at the below charts.
The RSI exceeds 70
As prices keep rising in an uptrend, the RSI will cross the 70 marks. This signals that buyers are dominant and the uptrend is likely to continue for a while. At this price point, enter a short buy trade. Eventually, the prices are bound to reverse and start falling. Just as the RSI crosses the 70 marks, you should enter a sell trade. You would expect the downtrend to continue for a while.
The RSI exceeds 30
The situation is the opposite now. There was a downtrend and the RSI finally reaches the 30 lines. When it crosses 30 you may enter a sell trade for a short time. The asset is now oversold so it means the sellers dominate the market. But not for long. Soon, the trend will start to reverse. When the RSI intersects the 30 lines from the bottom, you can open a buy position for a long period.
This is an example of trading along with the trend. The RSI is useful here to show you the best entry points.
Pros and Cons of Using RSI Indicator 👍👎
- Pros:
- Effective at identifying potential market reversals.
- Helps identify overbought or oversold conditions.
- Can be used across various timeframes and markets.
- Cons:
- May generate false signals in volatile markets.
- Not sufficient on its own, works best with other indicators.
- Requires careful interpretation and experience to use effectively.
| RSI Indicator Attributes | Description |
|---|---|
| Type of Indicator | Momentum Oscillator |
| Use | Identifies potential overbought/oversold conditions and trend reversals |
| Key Levels | 30 (Oversold) and 70 (Overbought) |
| Ideal Market Conditions | Works best in trending markets |
How to trade with the RSI divergence at Olymp Trade
The RSI helps you to determine when the asset is in the oversold and overbought areas. You may think that the oscillator follows the price fluctuations. Well, not always.
When the indicator is moving in the opposite direction to the prices, it is called divergence. This means that when the prices are falling during the downtrend, the indicator is rising. And when the prices are increasing along with the uptrend, the RSI is falling. It happens quite often.
What indicator divergence means? It shows that the trend is about to reverse. The accuracy of this assumption is pretty high, close to 80%.
Consider the exemplary chart below. Normally, the downtrend is characterized by lower highs and lower lows. On the price chart below you can observe it has lower lows and lower highs. Now, look at the RSI plot. See the difference in behavior? The RSI is not going deeper. Instead, there is a higher low. This implies that the buyers are preparing themselves to enter the market and the uptrend is inevitable.
This is a basic knowledge you should have about the RSI indicator. If you want to see how it works on the platform, I advise you to go to the free demo Olymp Trade account and practice there for a while.
Although the RSI is a useful tool in increasing your chances of a successful trade, keep in mind that you will still be facing risks. There are no guarantees when it comes to the market.
You are more than welcome to share your views in the comments section down below.
Good luck!
Q&A🔍
- Q: Can the RSI indicator be used for all types of assets?
- A: Yes, the RSI can be used across different types of assets including stocks, forex, commodities, and cryptocurrencies.
- Q: How reliable is the RSI for predicting trend reversals?
- A: While the RSI is a useful tool for predicting potential trend reversals, it should not be used alone. Combining it with other indicators and tools can increase its reliability.
- Q: What is RSI divergence and why is it important?
- A: RSI divergence occurs when the price of an asset and the RSI are moving in opposite directions. This can often signal a potential reversal in the trend.
- Q: Can the RSI help with risk management in trading?
- A: The RSI can assist with risk management by providing signals to potentially exit a position if the market is overbought or oversold.
- Q: Is there a best period setting for the RSI?
- A: The best period setting for the RSI can vary based on the asset and the trader’s strategy. However, a common setting is 14 periods.