The Relative Strength Index (RSI) is one of the popular oscillator indicators and is considered quite reliable. Since it was created by Welles Wilder in 1978, the RSI indicator is used in trading in all types of markets, including by forex traders. However, actually there are certain tricks in using the RSI that can affect the accuracy of trading results, but not many people know about them.
Traditionally, the RSI indicator is used to determine the right entry time by looking at overbought and oversold levels, as well as detecting possible changes in trend direction by observing divergences in price movements. Besides the usual functions of the RSI, here are three tips from traders that might be helpful in using this indicator.
Tip 1: In a strong trend, ignore the overbought and oversold RSI indicators.
When prices trend strongly over a relatively long period of time, the entry method by relying on the overbought and oversold RSI indicators becomes inaccurate.
This indicator is created by comparing the number of positive (higher) price changes with negative (lower) price changes for a certain period. The ratio is plotted in the range 0 to +100. If after that period of time the price doesn't change (such as when it's trending strongly), then the RSI will remain overbought (during an uptrend) or oversold (during a downtrend).
Consider the following case examples on the GBP/USD chart:
In the GBP/USD example above, the downtrend was strong and the RSI remained in the oversold area for a long period of time. In this case, if you buy when oversold, it will cause losses.
The solution is, before observing the RSI indicator, traders must first look at trend indicators. Trend strength indicators that are often used are MACD, Bollinger Bands and ADX.
Tip 2: Pay attention to the 50 level on the RSI indicator (center line).
All oscillator type indicators have a middle level or center line, usually at the 50 or 50% level. Likewise on the RSI indicator. This center line, which is often ignored, shows the momentum for a change in the direction of price movement when a retracement occurs, or even when there is a change in trend direction.
What is the function of the center line on the RSI indicator?
When the RSI penetrates the center line upwards, it signals a buy signal. And conversely, when it penetrates the center line downwards, it signals a sell signal. Examples as follows:
Tip 3: The use of the RSI indicator parameters needs to be adjusted to the trading time frame.
As a rule, the default time period parameter on the trading platform for almost all oscillator type indicators is 14, including the RSI. Based on experience, period 14 is suitable for the Daily time frame, but less accurate for lower trading time frames.
The maker of the RSI indicator, Welles Wilder, also recommends using a period of 14 on the Daily time frame. According to Wilder, the smaller the measurement time period, the more sensitive it will be, making it difficult to observe; whereas if the time period is greater, it will be less sensitive, thus affecting the measurement accuracy.
So, if you are going to use the RSI indicator on a time frame lower or higher than the Daily, you should not use the default parameters. If so, how is the adjustment?
Basically, the smaller the period setting, the more frequent trading signals will be generated. Daily traders with a time frame of 1 hour and below usually use the RSI period 9, while Scalpers use period 7. Meanwhile, medium and long term traders use periods 14 or 25.
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