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Sunday, January 6, 2008


RSI (Relative Strength Index) was developed in the 70’s by a trader named J Welles Wilder

Relative Strength Index, or RSI, is a momentum indicator that works similar to the stochastic in that it identifies overbought and oversold conditions in the market. The RSI compares the size of recent gains to recent declines to determine overbought and oversold conditions. It is also scaled from 0 to 100 with readings above 70 indicating overbought and under 30 indicating oversold.

The RSI can also be used to confirm trend formations. Typically traders would enter long when the RSI crosses the 30% line up, and short when it crosses the 70% line down. This method however can cause many false entries. Many traders wait until the RSI crosses the 50% line to confirm a possible new trend.

The above Eur/Usd 4 Hr chart shows 4 potential trades when the RSI (14 period) crossed above the 50% line. All but the second (from the left) identified strong new trends. The cross through 50% on the second trade only identified the trend when it was almost over. Had we entered at the early cross above 30 almost the entire move could have been caught.

As with most indicators the input figures can be adjusted to give earlier or later entries.. We can also see from the raggedness of the lines it is quite sensitive to price fluctuations even on a standard 14 period RSI.

When the RSI signals an overbought or oversold signal by crossing above or below the 70 or 30 lines this could be an early indication of a possible reversal. The crossing of the 50% line typically confirms the new trend.

The RSI is also useful in identifying divergence in the market. As with all indicators is best used in conjunction with other indicators.

1 comment:

Jason said...

Nice graph, Which is clearly explain about relative strength index. It can be used to confirm trend formations. Thanks for the information.....

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