RSI indicator - how to use? Instructions, recommendations

The index of relative strength is among the most popular indicators used by traders. It provides information on the strength of price movements on the charts, hence its name. So what is the RSI indicator? How to use it in trade? How to understand what he shows?

RSI indicator: description

Created by J. Wells Wilder, the Relative Strength Index (RSI) is a moment oscillator that measures the rate and change in price movements. Traditionally, according to Wilder, RSI shows overbought market when its value exceeds 70, and oversold when it is below 30. RSI indicator signals can warn about a trend reversal, the intersection of the central line, and determine the strength of the trend.

Wilder wrote about all of this in his 1978 book "New concepts in technical trading systems." Together with the parabolic SAR, the volatility index, the span index and the CSI index, he described the RSI indicator - how to use and how to calculate it. In particular, the author considered the following factors:

• Highs and lows;
• Figures of technical analysis;
• A failed swing;
• Support and resistance;
• Divergence.

Despite the fact that the Wilder indicators will soon turn 40, they have stood the test of time and remain extremely popular so far.

Calculation

The indicator is calculated by the formula: RSI = 100 - 100 / (1 + RS), where RS = average growth / average fall.

To simplify the calculation, the index is broken down into main components: RS, average growth and fall in the rate. In his book, Wilder suggested calculating the index based on 14 time intervals. The fall is expressed as positive, not negative numbers.

First, average growth and average fall over 14 periods are calculated.

• Average growth = the sum of growth for the last 14 periods / 14;
• Average drop = the amount of falls over the last 14 periods / 14.

Then the calculations are based on previous average and current incidence or growth:

• Average height = previous average height x 13 + current growth / 14;
• Average drop = previous average drop x 13 + current drop / 14.

This method of calculation is an anti-aliasing technique similar to the exponential moving average. This also means that the index values become more accurate as the settlement period increases.

Wilder's formula normalizes the RS and turns it into an oscillator that oscillates between zero and 100. In fact, the RS graph looks exactly like the RSI graph. The normalization step simplifies the finding of extremes, since the index is in a narrow range. The index of relative strength is 0, when the average increase is zero. With a 14-period RSI, a zero value indicates that the rate has declined for all 14 periods. Growth was absent. The index is 100, when the average depreciation is zero. This means that the rate has been growing for all 14 periods. There was no fall.

Based on the relative strength index, the stochastic oscillator Stochastic RSI is calculated:

• StochRSI = (RSI is the minimum RSI) / (maximum RSI is the minimum RSI).

The oscillator correlates the RSI level with its minimum and maximum values over a period of time. In the stochastic oscillator formula, RSI values are substituted for course values. Thus, Stochastic RSI is an indicator indicator - the second derivative of the exchange rate. Significantly increases the number of signals, so with it you should consider other instruments of technical analysis.

RSI indicator: how to use?

The standard number of periods for the relative strength indicator is 14, which means that it estimates the last 14 candles, or time intervals.

The indicator compares the average gain to the average loss and analyzes how many of the last 14 candles were bull bears or bear cubes, and also analyzes the size of each candle.

For example, if all 14 price candles are bullish, then the index is 100, and if all 14 candles are bearish, then 0 (or almost 100 and 0). And the index, equal to 50, will mean that 7 past candles were bearish, 7 were bullish, and the average profit and loss were equal.

Example 1. The screenshot below shows the EUR / USD chart. The white section includes the last 14 price candles. Of these, 13 were bullish and only 1 was bearish, resulting in a value of 85.

Example 2. The screenshot below shows the EUR / USD chart and 3 selected areas of 14 candles each to understand how the relative strength index is calculated.

• The first area highlights a very bearish period of 9 bear candles, 4 small bull candles and 1 candle pattern (doji). RSI of this period is 15, which signals a very strong bearish phase.
• The second section includes 9 bull candles and 5 mostly small bear candles. The indicator of this period was 70, indicating a relatively strong bullish trend.
• The third area includes 6 bull candles, 8 bearish and 1 doji, which leads to the value of index 34, indicating a moderate depreciation.

As you can see, the analysis of 14 candles quite accurately corresponds to the value of RSI for this period. Nevertheless, the indicator is useful in that it reduces the time required for data processing and also avoids mistakes during volatile market behavior.

Overbought and overbought

The basic idea is that when the relative strength index shows very high or very low values (greater than 70 or less than 30), the price indicates oversold or overbought prices. A high index means that the number of bullish candles has prevailed over the number of bearish ones. And since the course can not endlessly stamp only bullish candles, it is impossible to rely only on the RSI indicator to determine the trend reversal.

If 13 of the last 14 candles were bullish, and the index is well above 70, then it is likely that the bulls will retreat in the near future, but rely entirely on their forecasts for the RSI indicator is not worth it. The screenshot below shows two periods when it entered the oversold area (less than 30) and remained so for a long time. During the first period, the rate continued to fall for 16 days before the index returned above 30, and during the second period the rate continued to fall for 8 days, when the market was resold.

The calculation period for the trend strength index is 14 by default, but it can be reduced to increase the sensitivity of the indicator, or increased to reduce it. The 10-day RSI will reach overbought or oversold levels faster than the 20-day RSI.

The market is considered overbought when the value of RSI exceeds 70, and oversold when below 30. These traditional levels can also be adjusted to better meet security or requirements. Setting the RSI indicator by increasing the overbought to 80 or reducing the oversold to 20 will reduce the frequency of signals. Short-term traders sometimes use 2-period RSI, which allows you to look for overbought above 80 and oversold below 20.

The indicator of relative strength can not be used purely to determine the likely turning points. He also points out very strong trends when he remains in the oversold zone or overbought for a long time.

Breakthrough of the support and resistance line

As already mentioned, the relative strength index allows you to determine strong exchange rate trends. This turns it into an excellent tool when trading at support levels and course resistance. The figure shows the EUR / USD chart, and the black horizontal line is a widely known level equal to the 1.20 rate, which is the level of support and resistance.

You can see that the price has returned several times to the level of 1.2. For the first time, RSI showed values of 63 and 57. This meant that, although the trend was upward, its strength was inadequate. A strong level of resistance is difficult to break - a strong trend is needed to overcome it.

The second time the rate returned to the resistance level, the RSI was 71, which indicates a fairly strong bullish trend, but the resistance level stood still again. Until the last section, when the RSI showed a value of 76, the resistance level was overcome and the RSI rose to 85.

The indicator can serve as a tool for quantifying the strength of a course. Traders that use trading algorithms desperately need such information, and the indicator of relative strength comes at an opportune time.

RSI divergence

Another area where the RSI indicator is used is the strategy of identifying turning points by searching for divergence. The signals of discrepancy that the course provides are usually not supported by the underlying price dynamics. This is confirmed by the following.

The screenshot below shows two minima. During the first indicator was equal to 26, and the course movement, anticipating this point, included 8 bear candles, 3 bulls, 3 doji, the rate fell by a total of 1.45%. During the second low, RSI showed a higher value of 28, and the movement included 7 bear candles, 5 bulls, 2 doji and lost only 0.96%.

Although the rate reached a new, lower minimum, the background dynamics were not so bearish, and the second site was not strong. And the graph confirms this. The second low had a higher indicator (28 versus 26), although the rate showed that bears are losing power. Divergence often breaks down, double divergence is more reliable.

Positively negative reversals

Andrew Cardwell developed a system of positive-negative reversals for the relative strength index, which are opposite to bearish and bullish divergences. Unlike Wilder, Cardwell considered the bearish divergence to be a bull market. In other words, bearish differences form an upward trend. Similarly, bullish divergences are seen as bear market phenomena and indicate a downtrend.

A positive turn is formed when the indicator reaches a lower low, and the rate forms a higher minimum. The low minimum is not at the oversold level, but somewhere between 30 and 50.

Negative reversal is opposite to positive. RSI forms a higher maximum, but the rate forms a lower maximum. Again, the higher, as a rule, is located just below the overbought level at the level of 50-70.

Trend Id

The relative strength indicator tends to range from 40 to 90 in the bull market (uptrend) with levels of 40-50 serving as support. These ranges may vary depending on the RSI parameters, the strength of the trend and the volatility of the underlying asset.

On the other hand, the indicator fluctuates between 10 and 60 with a bear market (a downtrend) with levels of 50-60 as resistance.

Unsuccessful swing

The failed sweep, in the author's opinion, is a strong sign of an impending reversal. It is the signal that the RSI indicator gives. The description of it is as follows. Unsuccessful swings do not depend on the course. In other words, they focus exclusively on RSI signals and ignore the concept of divergence. A bullish unsuccessful swing occurs when the RSI falls below 30 (oversold), rises above 30, drops to 30, and then breaks the previous high. The goal is to achieve oversold levels and then a higher minimum than oversold levels.

A bearish unsuccessful swing occurs when the index moves above 70, drops, rebounds, does not reach 70, and then breaks out the previous low. The goal is the level of overbought, and then - the lower maximum is below the levels of overbought.

The rate is more important than the indicator

The universal torque oscillator RSI indicator is a time-tested efficiency. Despite the volatility of the markets, RSI remains as relevant today as it was in the days of Wilder. But time made some adjustments. Although Wilder considered overbought as a condition for reversal, it turned out that it could be a sign of strength. Bearish divergence still gives good signals, but traders should be careful during strong trends when it is normal. Despite the fact that the concept of positive and negative reversals somewhat undermines Wilder's interpretation, its logic makes sense and Wilder himself would not likely refuse to pay more attention to the behavior of the price. Positive and negative reversals place the price trend on the first plan, and the index - on the second, as it should be. Bearish and bullish divergences prefer the RSI indicator. How to use these tools depends on the trader.

The RSI indicator is a universal tool for determining the strength of a trend, searching for turning points or breaking through support and resistance lines. And although its value can be easily predicted by looking at the last 14 candles, RSI drawing on the course graphs will add stability and confidence in the trade. Quantitative evaluation of the strength of the course, its translation into interpreted figures will allow more effective decision-making and avoid guesses and subjective interpretations.