The RSI is the Relative Strength Index, and it is an oscillator which can assume values in a scale from 1 to 100. This indicator measures the speed of the price movements (momentum) comparing the wideness of the long trend with the wideness of the short one developed in the recent period. As any other oscillator that uses a relative scale with fixed minimum and maximum, the RSI tends to its middle value (50), and reaching new highs or lows is increasingly difficult, so it is not surprise that its values are often concentrated in the central area of the indicator.
The RSI compares the bullish days and the bearish ones, giving us an idea of the speed of the price movements. If the price accelerates, i.e. prices are rising / falling faster than before, then the RSI moves towards a certain end.
One of the most common uses of the RSI, like many other indicators, is to identify overbought and oversold areas; the novice traders mistakenly enter against the trend when the indicator is in overbought / oversold zone. Obviously this often leads to a wrong strategy; actually after the overbought / oversold there is always a movement in the opposite direction, but very often the permanence of a currency cross in the overbought /oversold zone can last for days or weeks, causing severe losses to the trader. For this reason, the best thing is looking for alternative strategies.
The differences may be a first correct approach to the use of the RSI; in this case, we have to look for moments when prices are creating new highs and lows, but such movements are denied by the values from RSI. For example, entering short on a cross when the RSI exits the overbought zone and at the same time the price rises to new highs can be a good trading strategy even if tainted by false signals.
Let’s check USD / JPY, for example. Between February and March 2012 USD / JPY entered an overbought phase with a firm RSI over 70; the RSI reached its top on February 22nd at 83, but as prices continued to rise the RSI began to fall, creating the classic divergence. In these situations, when is the trader called to operate? A fairly reliable strategy would be to wait for a first low of the RSI under 70 (in the example 63), and then to enter short when RSI will break downwards definitely this support For USD / JPY this would have allowed to start a very profitable trade.
Trading RSI Indicator
Another strategy is to insert the RSI combined with a moving average of the same indicator. When the RSI drills downward the moving average, our cross diminishes in value and it is therefore recommended to open short positions. On the contrary, when the moving average is crossed upwards, the cross rises in price and it's time to go long. The graph USD / MXN of 2012 gives us a concrete example of how to operate. In May, the RSI entered the overbought zone and persisted there until June the 4th, when, after falling below 70, it cut down the RSI moving average at 21 days. That signal would have triggered a very profitable short signal on USD / MXN. The same indication was received between January and February 2012; the RSI left the oversold zone and crossed the moving average providing a bullish signal.
Trading RSI Indicator with Moving Averages
Like most of the oscillators, the RSI analysis must be coordinated with other indicators. Traders that operate on long-term can misunderstand the meaning of a RSI above 70 or below 30. The example of USD / CHF is very important. USD / CHF entered the overbought zone in September 2011 increasing upwards the 200-days moving average. For those looking for long lasting trends, this was a bullish signal, not a bearish one; the trader would have had to wait at least a return of the RSI below 50 to enter long on USD / CHF.
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