How do I use the Relative Strength Index (RSI) to create a forex trading strategy?
The relative strength index (RSI) is most commonly used to indicate temporary overbought or oversold conditions in a market. An intraday forex trading strategy can be devised to take advantage of indications from the RSI that a market is overextended and therefore likely to retrace.
The RSI is a widely used technical indicator, an oscillator that indicates a market is overbought when the RSI value is over 70 and indicates oversold conditions when RSI readings are under 30. Some traders and analysts prefer to use the more extreme readings of 80 and 20. A weakness of the RSI is that sudden, sharp price movements can cause it to spike repeatedly up or down, and, thus, it is prone to giving false signals. Also, it is not uncommon for price to continue to extend well beyond the point where the RSI first indicates the market as being overbought or oversold. For this reason, a trading strategy using the RSI works best when supplemented with other technical indicators.
The following is an intraday forex trading strategy that employs the RSI and at least one additional confirming indicator:
• Monitor the RSI for readings indicating the market is overbought or oversold.
• Consult other momentum or trend indicators for confirming signs of an impending retracement. For example, if the RSI shows oversold readings, a retracement to the upside is anticipated.
• Only initiate a trade looking to profit from a retracement if one these additional conditions is met:
1. The moving average convergence divergence (MACD) has shown divergence from price (for example, if price has made a new low, but the MACD has not and has turned from a downslope to an upslope), or.
2. The average directional index (ADX) has turned in the direction of a possible retracement.
• If the above conditions are met, then initiate the trade with a stop-loss order just beyond the recent low or high price, depending on whether the trade is a buy trade or sell trade, respectively.
• The initial profit target can be the nearest identified support/resistance level.

Rsi strategy

Developed by Larry Connors, the 2-period RSI strategy is a mean-reversion trading strategy designed to buy or sell securities after a corrective period. The strategy is rather simple. Connors suggests looking for buying opportunities when 2-period RSI moves below 10, which is considered deeply oversold. Conversely, traders can look for short-selling opportunities when 2-period RSI moves above 90. This is a rather aggressive short-term strategy designed to participate in an ongoing trend. It is not designed to identify major tops or bottoms. Before looking at the details, note that this article is designed to educate chartists on possible strategies. We are not presenting a standalone trading strategy that can be used right out of the box. Instead, this article is meant to enhance strategy development and refinement.
There are four steps to this strategy and levels are based on closing prices. First, identify the major trend using a long-term moving average. Connors advocates the 200-day moving average. The long-term trend is up when a security is above its 200-day SMA and down when a security is below its 200-day SMA. Traders should look for buying opportunities when above the 200-day SMA and short-selling opportunities when below the 200-day SMA.
Second, choose an RSI level to identify buying or selling opportunities within the bigger trend. Connors tested RSI levels between 0 and 10 for buying, and between 90 and 100 for selling. Connors found that returns were higher when buying on an RSI dip below 5 than on an RSI dip below 10. In other words, the lower RSI dipped, the higher the returns on subsequent long positions. For short positions, the returns were higher when selling-short on an RSI surge above 95 than on a surge above 90. In other words, the more short-term overbought the security, the greater the subsequent returns on a short position.
The third step involves the actual buy or sell-short order and the timing of its placement. Chartists can either watch the market near the close and establish a position just before the close or establish a position on the next open. There are pros and cons to both approaches. Connors advocates the before-the-close approach. Buying just before the close means traders are at the mercy of the next open, which could be with a gap. Obviously, this gap can enhance the new position or immediately detract with an adverse price move. Waiting for the open gives traders more flexibility and can improve the entry level.
The fourth step is to set the exit point. In his example using the S&P 500, Connors advocates exiting long positions on a move above the 5-day SMA and short positions on a move below the 5-day SMA. This is clearly a short-term trading strategy that will produce quick exits. Chartists should also consider setting a trailing stop or employing the Parabolic SAR. Sometimes a strong trend takes hold and trailing stops will ensure that a position remains as long as the trend extends.
Where are the stops? Connors does not advocate using stops. Yes, you read right. In his quantitative testing, which involved hundreds of thousands of trades, Connors found that stops actually “hurt” performance when it comes to stocks and stock indices. While the market does indeed have an upward drift, not using stops can result in outsized losses and large drawdowns. It is a risky proposition, but then again trading is a risky game. Chartists need to decide for themselves.
Trading Examples.
The chart below shows the Dow Industrials SPDR (DIA) with the 200-day SMA (red), 5-period SMA (pink) and 2-period RSI. A bullish signal occurs when DIA is above the 200-day SMA and RSI(2) moves to 5 or lower. A bearish signal occurs when DIA is below the 200-day SMA and RSI(2) moves to 95 or higher. There were seven signals over this 12-month period, four bullish and three bearish. Of the four bullish signals, DIA moved higher three of the four times, which means these signals could have been profitable. Of the three bearish signals, DIA moved lower only once (5). DIA moved above the 200-day SMA after the bearish signals in October. Once above the 200-day SMA, the 2-period RSI did not move to 5 or lower to produce another buy signal. As far as a gain or loss, it would depend on the levels used for the stop-loss and profit taking.
The second example shows Apple (AAPL) trading above its 200-day SMA for most of the timeframe. There were at least ten buy signals during this period. It would have been difficult to prevent losses on the first five because AAPL zigzagged lower from late February to mid-June 2011. The second five signals fared much better as AAPL zigzagged higher from August to January. Looking at this chart, it is clear that many of these signals were early. In other words, Apple moved to new lows after the initial buy signal and then rebounded.
As with all trading strategies, it is important to study the signals and look for ways to improve the results. The key is to avoid curve fitting, which decreases the odds of success in the future. As noted above, the RSI(2) strategy can be early because the existing moves often continue after the signal. The security can continue higher after RSI(2) surges above 95 or lower after RSI(2) plunges below 5. In an effort to remedy this situation, chartists should look for some sort of clue that prices have actually reversed after RSI(2) hits its extreme. This could involve candlestick analysis, intraday chart patterns, other momentum oscillators or even tweaks to RSI(2).
RSI(2) surges above 95 because prices are moving up. Establishing a short position while prices are moving up can be dangerous. Chartists could filter this signal by waiting for RSI(2) to move back below its centerline (50). Similarly, when a security is trading above its 200-day SMA and RSI(2) moves below 5, chartists could filter this signal by waiting for RSI(2) to move above 50. This would signal that prices have indeed made some sort of short-term turn. The chart above shows Google with RSI(2) signals filtered with a cross of the centerline (50). There were good signals and bad signals. Notice that the October sell signal did not go into effect because GOOG was above the 200-day SMA by the time RSI moved below 50. Also, note that gaps can wreak havoc on trades. The mid-July, mid-October and mid-January gaps occurred during earnings season.
Conclusions.
The RSI(2) strategy gives traders a chance to partake in an ongoing trend. Connors states that traders should buy pullbacks, not breakouts. Conversely, traders should sell oversold bounces, not support breaks. This strategy fits with his philosophy. Even though Connors' tests show that stops hurt performance, it would be prudent for traders to develop an exit and stop-loss strategy for any trading system. Traders could exit longs when conditions become overbought or set a trailing stop. Similarly, traders could exit shorts when conditions become oversold. Keep in mind that this article is designed as a starting point for trading system development. Use these ideas to augment your trading style, risk-reward preferences, and personal judgments. Click here for a chart of the S&P 500 with RSI(2).
Suggested Scans.
RSI(2) Buy Signal.
This scan searches for stocks that have just had an RSI(2) Buy Signal.
RSI(2) Sell Signal.
This scan searches for stocks that have just had an RSI(2) Sell Signal.
Further Study.
From the creators of the RSI(2) strategy, this book details more trading strategies and includes a chapter on exits. Connors also shows the details of his back-tests and provides guidelines to improve trading results.

RSI And How To Profit From It.
We all know there are no magic indicators but there is one that certainly acted like magic over the past 10 years or so. What indicator is it? Our reliable RSI. In this article we are going to look at two trading models that were first talked about in the book, “Short Term Trading Strategies That Work” by Larry Connors and Cesar Alvarez. It has been well established in various articles that a 2-period RSI on the daily chart of the stock index markets has been a fantastic tool for finding entry points. Sharp price drops in the S&P E-Mini futures during bullish markets have historically (since the year 2000) been followed by reversals. These reversals can often be detected by using the standard RSI indicator with a period value of two. Place this indicator on a daily chart and look for points when the indicator falls below five, for example. These extreme low points are buying opportunities.
Values below 5 are green. These are buy points.
RSI(2) System.
We can turn this into a simple trading model to test the effectiveness of the RSI(2) indicator on the E-mini S&P. In short, we wish to go long on the S&P when it experiences a pullback in a bull market. We can use a 200-day simple moving average to determine when we are in a bull trend and using a 2-period RSI to locate high probability entry points. We can then exit when price closes above a 5-day simple moving average. The rules are clear and simple:
Price must be above its 200-day moving average. Buy on close when cumulative RSI(2) is below 5. Exit when price closes above the 5-day moving average. Use a $1000 catastrophic stop loss.
The system backtest was performed from September 1997 through March 2012. A total of $50 for commissions and slippage was deducted per round trip. Below is a chart of what this system would look like along with the system results.
RSI(2) System Results.
Percent Winners: 67%
These results are great considering we have such a simple system. This demonstrates the power the RSI(2) indicator has had now for well over a decade. Just with this concept alone you can develop several trading systems. For now, let’s see if we can we improve upon these results.
Accumulated RSI(2) Strategy.
Larry Conners adds a slight twist to the RSI(2) trading model by creating an accumulated RSI value. Instead of a single calculation we will be computing a running daily total of the 2-period RSI. In this case, we are going to use the total of the 2-period RSI for the past three days. When you keep an accumulated value of the RSI(2) you smooth out the values. Below is a chart comparing the standard 2-period RSI indicator with an accumulated 2-period RSI indicator. You can see how much smoother our new indicator is. This is done to reduce the number of trades in hopes of capturing the quality trades. In short, it’s an attempt to improve the efficiency of our original trading model.
Accumulated RSI in top pane. Standard RSI in lower pane.
Price must be above its 200-day moving average. Buy on close when cumulative RSI(2) of the past three days is below 45. Exit when RSI(2) of the close of current day is above 65. Use a $1000 catastrophic stop loss.
Accumulated RSI(2) System Results.
Percent Winners: 67%
S&P Cash Market.
What would the 2-period RSI system look like trading 100 shares of the S&P cash market going back to 1993? It does rather well.
Conclusions.
So which one is better? The accumulated strategy worked as intended. It increased the efficiency of the standard RSI(2) trading model by reducing the number of trades, yet produced about the same amount of net profit. As a bonus, the drawdown was slightly smaller. While both systems do a fantastic job, the accumulation strategy may do a slightly better job. The Accumulated RSI(2) strategy will work well on the mini Dow as well as the two ETFs, DIA and SPY.
The EasyLanguage code is available below as a free download. There is also a TradeStation workspace. Please note, the trading concept and the code as provided is not a complete trading system. It is simply a demonstration of a robust entry method that can be used as a core of a trading system. So, for those of you who are interested in building your own trading systems this concept may be a great starting point.
Get The Book.
TradeStation RSI(2) WorkSpace.
2013 Update:
An additional article was published in 2013 which updates the RSI system and explores it in more detail. Read it here.
About the Author Jeff Swanson.
Jeff is the founder of System Trader Success – a website and mission to empowering the retail trader with the proper knowledge and tools to become a profitable trader the world of quantitative/automated trading.
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The Ivy Portfolio.
Improving The Simple Gap Strategy, Part 1.
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R&D Blog.
I. Trading Strategy.
Developer: Larry Connors (The 2-Period RSI Trading Strategy), Welles Wilder (The RSI Momentum Oscillator). Source: (i) Connors, L., Alvarez, C. (2009). Short Term Trading Strategies That Work . Jersey City, NJ: Trading Markets; (ii) Wilder, J. W. (1978). New Concepts in Technical Trading Systems . Greensboro: Trend Research. Concept: The long equity trading system based on the 2-Period RSI (Relative Strength Index). Research Goal: Performance verification of the simple trading strategy that buys pullbacks in a bull market. Specification: Table 1. Results: Figure 1-2. Trade Filter: The 2-Period RSI closes below RSI_Threshold (Default Value: RSI_Threshold = 5). Portfolio: Five equity futures markets (DJ, MD, NK, NQ, SP). Data: 36 years since 1980. Testing Platform: MATLAB®.
II. Sensitivity Test.
All 3-D charts are followed by 2-D contour charts for Profit Factor, Sharpe Ratio, Ulcer Performance Index, CAGR, Maximum Drawdown, Percent Profitable Trades, and Avg. Win / Avg. Loss Ratio. The final picture shows sensitivity of Equity Curve.
Tested Variables: RSI_Threshold & Exit_Look_Back (Definitions: Table 1):
Figure 1 | Portfolio Performance (Inputs: Table 1; Commission & Slippage: $0).
The Relative Strength Index (RSI) is a momentum oscillator that compares the magnitude of recent gains to recent losses to determine overbought and oversold conditions.
RSI(Close, RSI_Look_Back) is the Relative Strength Index of the close price over a period of RSI_Look_Back;
Default Value: RSI_Look_Back = 2.
We use an exponential smoothing.
Up[i] = max(Close[i] − Close[i − 1], 0);
Down[i] = max(Close[i − 1] − Close[i], 0);
AvgUp[i] = (AvgUp[i − 1] * (RSI_Look_Back − 1) + Up[i]) / RSI_Look_Back;
AvgDown[i] = (AvgDown[i − 1] * (RSI_Look_Back − 1) + Down[i]) / RSI_Look_Back;
RS[i] = AvgUp[i] / AvgDown[i];
RSI[i] = 100 − 100/(1 + RS[i]);
The first “AvgUp” (i. e. AvgUp[1] ) is calculated as a simple average of “Up” values over a period of RSI_Look_Back.
The first “AvgDown” (i. e. AvgDown[1]) is calculated as a simple average of “Down” values over a period of RSI_Look_Back.
MA(Close, Setup_Look_Back) is a simple moving average of the close price over a period of Setup_Look_Back;
Default Value: Setup_Look_Back = 200;
Setup Rule: Close[i] > MA[i];
The RSI closes below RSI_Threshold;
Default Value: RSI_Threshold = 5;
Filter Rule: RSI[i] < RSI_Threshold;
A buy at the open is placed after a bullish Setup/Filter.
Note: In the original model, a buy at the close is placed on the same bar as a bullish Setup/Filter.
Default Value: Exit_Look_Back = 5.
Long Exit: A sell at the open is placed if Close[i − 1] > MA[i − 1];
Stop Loss Exit: ATR(ATR_Length) is the Average True Range over a period of ATR_Length. ATR_Stop is a multiple of ATR(ATR_Length). Long Stop: A sell stop is placed at [Entry − ATR(ATR_Length) * ATR_Stop].
Exit_Look_Back = [5, 30], Step = 1.
Portfolio = 5 Equity Futures (DJ, MD, NK, NQ, SP)
ATR_Stop = 6 (ATR.
Average True Range)
Table 1 | Specification: Trading Strategy.
III. Sensitivity Test with Commission & Slippage.
Tested Variables: RSI_Threshold & Exit_Look_Back (Definitions: Table 1):
Figure 2 | Portfolio Performance (Inputs: Table 1; Commission & Slippage: $50 Round Turn).
IV. Benchmarking.
We benchmark the base case strategy (default parameters) against alternatives:
Case #1: RSI_Threshold = 5; Exit_Look_Back = 5 (Base Case).
Case #2: RSI_Threshold = 5; Exit_Look_Back = 10.
Case #3: RSI_Threshold = 10; Exit_Look_Back = 10.
Case #4: RSI_Threshold = 15; Exit_Look_Back = 10.
Table 2 | Inputs: Table 1; Fixed Fractional Sizing: 1%; Commission & Slippage: $50 Round Turn.
V. Research.
Connors, L., Alvarez, C. (2009). Short Term Trading Strategies That Work . Jersey City, NJ: Trading Markets:
Most traders use the 14-period RSI. But our studies have shown that statistically, there is no edge using the 14-period RSI . However, when you shorten the time frame of the RSI (meaning you go much lower than the 14-period) you start seeing some very impressive results. Our research shows that more robust and consistent results are obtained by using a 2-period RSI and we have built many trading methods that incorporate the 2-period RSI […] The lower the RSI, the greater the performance. The average returns of stocks with a 2-period RSI reading below 2 were greater than those stocks with a 2-period RSI reading below 5, etc.
VI. Rating: Relative Strength Index (RSI) Model | Trading Strategy.
VII. Summary.
(i) The trading strategy based on the 2-Bar Relative Strength Index underperforms alternative momentum models; (ii) The preferred parameters are: 5 ≤ RSI_Threshold ≤ 13; 8 ≤ Exit_Look_Back ≤ 13 (Figure 1-2).
CFTC RULE 4.41: HYPOTHETICAL OR SIMULATED PERFORMANCE RESULTS HAVE CERTAIN LIMITATIONS. UNLIKE AN ACTUAL PERFORMANCE RECORD, SIMULATED RESULTS DO NOT REPRESENT ACTUAL TRADING. ALSO, SINCE THE TRADES HAVE NOT BEEN EXECUTED, THE RESULTS MAY HAVE UNDER-OR-OVER COMPENSATED FOR THE IMPACT, IF ANY, OF CERTAIN MARKET FACTORS, SUCH AS LACK OF LIQUIDITY. SIMULATED TRADING PROGRAMS IN GENERAL ARE ALSO SUBJECT TO THE FACT THAT THEY ARE DESIGNED WITH THE BENEFIT OF HINDSIGHT. NO REPRESENTATION IS BEING MADE THAT ANY ACCOUNT WILL OR IS LIKELY TO ACHIEVE PROFIT OR LOSSES SIMILAR TO THOSE SHOWN.
RISK DISCLOSURE: U. S. GOVERNMENT REQUIRED DISCLAIMER | CFTC RULE 4.41.
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RSI indicator trading strategy, 5 systems + back test results!
RSI indicator trading strategy – 5 systems.
Digging into the quintessential overbought oversold indicator!
The RSI indicator is a cruel mistress!
She lure’s us in with promises of easy money and trading success,
only to drain your trading account balance in a run of terrible stoploss strikes, Even thought the indicator said BUY!
Oscillator indicators in general, are risky and unreliable beasts.
They might look friendly and approachable at first, only to BITE your hand off just when you are most comfortable!
The RSI indicator is usually the go to oscillator for the novice trader when deciding to enter that first trade.
There is a simple, valid reason for this;
The RSI indicator is simple to read and understand.
and it “APPEARS” to get great results when given the visual back-test!
( Come on, admit it, we have all done it! We take a quick glance at the RSI indicator in search of that sweet confirmation bias when we are just itching to make a trade. )
It is almost impossible to resist the siren call of a trading signal from our favorite indicator.
But approaching trading in a passive fashion like this is dangerous and will lead to the destruction of your account eventually!
In this article I will teach you how to avoid some of the major pitfalls that beset most beginner traders when it comes to the RSI indicator.
I am going to show you a few important things:
I am going to break down the RSI indicator so you understand it from head to toe. I will explain the top 5 RSI trading strategies that we hear so much about, what they mean and how to trade using them. I will back test each of those strategies against the EURCHF over a 16 month period and see how they actually performed, using a sample starting account of $1000, and a sensible stoploss strategy.
After reading this article you will Know the RSI indicator inside out,
YOU WILL BE better informed on the risks of using each of the RSI trading strategies to generate trading signals,
the next time the siren calls, you will think twice about placing that trade!
relative strength index calculation.
These are the nitty gritty details on how the RSI indicator is built.
In reality your charting software will do this calculation for you, thats what technology is for!
1: Pick the base number of periods on which to base the study.
2: compare todays closing price with yesterdays.
3: add all the upward movements in points between closing prices.
4: add all the downwards movements between closing prices.
5: calculate the EMA ( exponential moving average ) of the upward and downward price movements.
6: calculate the relative strength,
RS = EMA Upward Price Movements / EMA Downward Price Move ments.
7: Calculate the Relative Strength Index (RSI):
RSI definition, what does it all mean for my trading?
The RSI indicator Has definitely got one up over its competing oscillator in the fact that it has fixed points extremes at 0 and 100.
Rather than the relative floating extremes of say the Momentum or Rate of change oscillators.
In that sense it does give the trader a base to work from in judging one period of market action to another.
The RSI indicator is also smoother than it’s big brothers, Because it uses the Exponential moving average, it tends to be less jumpy and more consistent.
In general the RSI is interpreted as follows;
If the indicator is below 30, then the price action is considered weak and possibly oversold.
If it is reading above 70, then the asset is after a strong uptrend and could be overbought.
Because the RSI is used as a tool to indicate extremes in price action, then the temptation is to use it to place contrarian trades,
Buying when the indicator crosses 30 to the upside means you are counting on the trend reversing and then profiting from it. The same is true for selling when the RSI crosses down below 70 and using this a sign that the market is reversing from a strong uptrend.
Life is never that simple though, and more often than not, you will find that the risk involved in this type of simplistic approach is ruinous to you account balance.
New traders tend to gravitate to the RSI when attempting to delve into analysis for the first time.
It is easy to aproach and easy to understand, it has fixed overbought and oversold levels and it tends to be correct over longer periods,
I can see why it is so attractive to all of us,
However, you cannott ignore the hugh failings of the RSI indicator in a strong trend!
It can stay at 90 for days on end,
dancing above the overbought line like it is on speed at a london rave in 1992!
This is no good to the novice trader who pressed the sell button without placing a stop!
Some of us (like myself ) can only learn the hard way!
Here are some quick lessons:
Wait for conformation before considering a trade,
The RSI can remain at extreme levels for long periods in a strong trend.
Dont jump right in when you see a reading of 90, first allow the RSI line to fall back below the overbought line to at least give a stoploss level to trade off .
Watch the Centreline for trend confirmtion.
If the RSI line reaches an extreme and then returns to the centreline it is a better indication of a turning point in the trend. Waiting for this to occur can cut out those nasty impulsive trades!
It is common for technical traders to watch the centreline to show shifts in trend,
If the RSI is above 50, then it is considered a bullish uptrend, and if its below 50, then a bearish downtrend is in play.
Simple RSI strategy back test:
Over the last year of trading in EUR/CHF there has been:
From the conventional viewpoint, this means the trader got 5 sell signals and 3 buy signals.
Lets see how that worked out for him!
the RSI indicator hit the 30 line to indicate an oversold condition.
The trader uses this signal as an opportunity to buy the market.
this signal led to a 300 point rise without triggering a 50 point stop loss.
that’s a 300 point gain in your account!
the RSI indicator hit the 70 line to indicate an overbought condition.
The trader uses this signal as an opportunity to sell the market.
this signal led to a 150 point rise.
the market triggered a 50 point stop loss.
that’s a 50 point loss in your account!
the RSI indicator hit the 70 line to indicate an overbought condition.
The trader uses this signal as an opportunity to sell the market.
this signal led to a 400 point rise in the market!
the market triggered a 50 point stop loss.
that’s a 50 point loss in your account!
the RSI indicator hit the 70 line to indicate an overbought condition.
The trader uses this signal as an opportunity to sell the market.
this signal led to a 150 point rise in the market!
the market triggered a 50 point stop loss.
that’s another 50 point loss in your account!
The trader uses this signal as an opportunity to sell the market.
this signal led to a 250 point rise in the market!
the market triggered a 50 point stop loss.
that’s another 50 point loss in your account!
the RSI indicator hit the 30 line to indicate an oversold condition.
The trader uses this signal as an opportunity to buy the market.
this signal led to a 220 point rise without triggering a 50 point stop loss.
that’s a 220 point gain in your account!
the RSI indicator hit the 70 line to indicate an overbought condition.
The trader uses this signal as an opportunity to sell the market.
this signal led to a 130 point rise in the market!
the market triggered a 50 point stop loss.
that’s a 50 point loss in your account!
the RSI indicator hit the 30 line to indicate an oversold condition.
The trader uses this signal as an opportunity to buy the market.
this signal led to a 100 point decline.
while triggering a 50 point stop loss.
that’s a 50 point loss in your account!
In total the trader made 220 point gain in their trading account over 8 trades.
This was done with 2 winning trades and 6 loosing trades.
How to use rsi indicator in forex trading.
In order to get real value from the RSI indicator and take advantage of its benefits,
You need to approach it cautiously and interpret it a little deeper.
Here are a few techniques that you can use to cut out a lot of false signals.
Failure swings;
As I mentioned above,
The problem faced by every trader who uses the RSI indicator is that the market may well continue in its trend despite the fact that it hit an extreme reading,
It might even go on to leave that price level behind in the distance depending on the strength of the trend.
For this reason there came about the concept of the failure swing, in order to interpret the index better.
There is both the bearish and bullish failure swing.
A ‘bearish failure swing’ happens when the RSI enters the overbought zone at 70 and then comes back down below the 70 mark again.
In this case, a short position will be entered only after the RSI cuts down through the 70 line from the top.
The ‘bullish failure swing’ occurs when the RSI enters the oversold zone at 30 and then rallies out again and rises above the 30 line again.
The trader uses this rise above the 30 line as a trigger to go long.
Divergence:
Positive divergence happens when the price of an asset is drifting lower yet the RSI is starting to trend higher.
This could mean that the price is nearing a bottom and will probably turn up soon.
Negative divergence happens the opposite way, the price is driving higher, but the RSI has stalled and is beginning to turn lower.
When this occurs it is likely that the price will stop rising soon after. And then follow the RSI lower.
Trend confirmation:
The RSI can be useful as a tool for trend confirmation.
In a strong upward trending environment, the RSI rarely falls below 40, and will most always stick to the 50 – 80 range.
The corollary is true for a downtrend.
In this case the range will below the centreline and spike into the lower end of the indicator.
Overbought and oversold indications:
the standard settings for an overbought reading is 70 and for oversold it is 30.
this can be changed by the user to suit their own style.
I generally look for the RSI to register several extreme readings in a row before placing any great weight on the signals.
Centreline crossing:
When the RSI crosses the centreline it is a stronger signal that a trend change has happened than a simple extreme reading above or below the 70-30 lines.
When the indicator crosses the centreline to the upside, it means that the average gains are exceeding the average losses over the period.
The opposite is true for a downside cross.
When a centreline cross happens, it can be a good time to think about trade entry on a fresh pullback in price.
RSI trendline breaks:
RSI line itself can be interpreted by trendline analysis.
Its a simple trick but it is a useful analysis tool.
For example in an upward trending market,
Draw a line connecting the dips in the RSI line, if the RSI breaks this trendline to the downside it is an early indicator of an impending change.
A break of the RSI trendline often precedes a break of the price trendline on a price chart.
Relative strength index trading strategies.
Compound RSI Strategies:
A compound strategy is when you use two indicators together.
It is always advised to balance the signal of one indicator against another, this will help to cut out alot of false signals.
There are a few indicators that pair well with the RSI and using them together can proved better trading signals.
All of the above trading strategies should always be used with a risk management strategy alongside.
RSI, engulfing candlestick strategy:
In this trading strategy,
We combine the RSI indicator along with an engulfing candle stick.
This strategy will generate far less trades so you can afford to extend the stop loss position.
Only enter the market whenever the RSI gives an overbought or oversold signal which is supported by the a bullish or bearish engulfing candle.
Close the position on a solid break of the opposite RSI line.
The RSI indicator hit the 30 line to indicate an oversold condition.
The trader uses this signal as an opportunity to buy the market.
The trader waits to get an engulfing candle to confirm the signal.
after the engulfing candle occurred, the trader enters at the open of the next days trade.
this signal led to a 550 point rise without triggering a 100 point stop loss.
that’s a 550 point gain in your account!
The RSI indicator hit the 30 line to indicate an oversold condition.
The trader uses this signal as an opportunity to buy the market.
The trader waits to get an engulfing candle to confirm the signal.
after the engulfing candle occurred, the trader enters at the open of the next days trade.
this signal led to a 175 point rise without triggering a 100 point stop loss.
that’s a total gain of 725 points in your account in two trades!
that’s a solid performance by any ones standard.
In this trading strategy,
We combine the RSI indicator with the MACD.
First, enter the market whenever the RSI gives an overbought or oversold signal which is supported by a MACD signal line crossing.
And then close the position if either indicator provides an exit signal.
The RSI indicator hit the 30 line to indicate an oversold condition.
The trader uses this signal as an opportunity to buy the market.
The trader waits for a signal line cross to confirm the signal.
after the engulfing candle occurred, the trader enters at the open of the next days trade.
this signal led to a 400 point gain without triggering a 50 point stop loss.
This combination indicator did not generate any further trades in the above time period.
RSI + MA Cross:
In this trading strategy,
We place a trade when the RSI gives an overbought or oversold signal which is supported by a crossover of the moving averages.
Close the position on an RSI divergence.
Although this trading system came close, it did not generate any signals over the 16 month time period!
I think we can count this one out as a useful trading system.
RSI Bollinger band:
In this trading strategy,
We combine the RSI indicator along with a Bollinger band squeeze.
First we wait for a Bollinger band squeeze to occur on a daily chart, the squeeze should come to within 150 points or so.
Only enter the market whenever the RSI gives an overbought or oversold failure swing.
which is supported by a tag of the bands in the same direction.
A bullish signal happens when the rsi falls below 30 and then rises above 30 again.
Then a daily candle touches the upper Bollinger band.
Close the position on an RSI divergence.
Again this trading system did not give any signal over the time period. We can count out this system also!
So there you have it!
Here are the results of the above back tests of the 5 trading systems;
Simple RSI strategy = In total this system made 220 point gain over 8 trades, 2 winning trades and 6 loosing trades. RSI, candlestick strategy = In total this system made 725 point gain over 2 trades, 2 winning trades and 0 loosing trades. RSI, MACD strategy = In total this system made 400 point gain over 1 trades, 1 winning trade and 0 loosing trades. RSI, MA Cross strategy = In total, this system made 0 trades and 0 points gained, RSI, Bollinger band strategy = In total, this system made 0 trades and 0 points gained,
It is plain to see that the best system in this back test is the RSI candlestick strategy. It did not give many trading signals but, when it did, They were fantastic signals.
And think about it;
The average hedge fund makes about 20% a year, with the very real risk of loosing a whole lot! and what does the average savings account return?
The winning strategy above made about 100% ( depending on the $/pip amount / or lot size ) on your initial capital while risking about 10 – 15% on each of the two trades.
That is some good food for thought!
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Author: E. Glynn.
I am a trend trader, I allocate 99% of my time to studying market action and 1% trading. I base all trading decisions on Elliott wave analysis, technical analysis, momentum indicators and sentiment readings.
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