RSI (Relative Strength Index):
The Relative Strength Index (RSI),is an extremely useful and popular momentum oscillator.The RSI compares the magnitude of recent gains to the magnitude of recent losses and turns that information into a number that ranges from 0 to 100.[You must be registered and logged in to see this image.]
There are multiple ways that you can use the RSI.You can use it to spot Overbought/Oversold levels,to spot divergences that show you a trend is losing steam,or you can use it to confirm a trend.Overbought/Oversold
RSI above 70 usually means the currency pair is overbought, so a top might be near. RSI below 30 means the currency pair is oversold so a bottom might be near.
Generally, if the RSI rises above 30 it is considered a bullish signal. If the RSI falls below 70, it is a bearish signal.
Some traders identify the long-term trend and then use extreme readings for entry points. If the long-term trend is bullish, then oversold readings could mark potential entry points. [You must be registered and logged in to see this image.]Divergences
Buy and sell signals can also be generated by looking for positive and negative divergences between the RSI and the currency pair price.
If the price reaches a higher high but RSI isn’t able to reach a new high, there’s a bearish divergence. If prices reach a new low, and RSI can’t reach a new low, there’s a bullish divergence.
Divergences that occur after an overbought or oversold reading usually provide more reliable signals.
Here’s an example of a bearish divergence:[You must be registered and logged in to see this image.]
On point 2, EUR/USD was at an higher level while the RSI was at a lower level comparing to point 1. This is a clear bearish divergence on RSI. On this example, EUR/USD went from 0.9265 to 0.8635 which represents a 630 pips downtrend.
You can also see that around 0.8635 the RSI reached the oversold level for the first time, and this represented the exact bottom for EUR/USD.
Let’s take a look at another example. This time we’re looking at a bullish divergence on RSI:[You must be registered and logged in to see this image.]
As you can easily see, at point 2 the EUR/USD was at a new low, while RSI was at an higher value. This was a clear bullish divergence that pointed to the upside.
EUR/USD started a rally of almost 1000 pips until it reached a top when the RSI clearly marked an overbought point. Once again, RSI was able to spot top and bottoms like few indicators can.[You must be registered and logged in to see this image.]
On this example you can notice that at point 2, the price is around the same level as at point 1. However, RSI is clearly above. RSI is pointing for a rally in price due to this bullish divergence.
If you had purchased GBP/USD on this bullish divergence and sold it once the RSI signaled an overbought market, you would have bought around 1.7475 and exited the trade around 1.8200 with 725 pips profit.Centerline Crossover
A reading above 50 indicates that average gains are higher than average losses and a reading below 50 indicates that losses are winning the battle.
Some traders look for a move above 50 to confirm bullish signals or a move below 50 to confirm bearish signals.[You must be registered and logged in to see this image.]
In this chart you can see a strong uptrend on EUR/USD confirmed by an RSI above 50. When RSI crossed below 50, the trend was starting to lose some strength. RSI let you know this in advance.