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What is the Relative Strength Index (RSI) And How To Use It?

March 13, 2016

RSI is an oscillator of price movement strength which varies in the range from 0 to 100. It was designed by John Welles Wilder and was initially introduced in his book “New Concepts in Technical Trading Systems”. The concepts that were considered new in 1978 are no longer new for us now, but RSI is one of the leading indicators even today.

Relative Strength Index measures the magnitude and speed of price movements. In other words, it moves up if the price increases, and the distance it moves depends on the strength of the price movement. The default setting for this indicator is 14, but some traders use 21. If you use 21, the RSI indicator will move slower and will generate fewer signals, although these signals are more reliable.

One of the main advantages of this indicator is that it may show the oversold and overbought price state with two levels: 70 and 30. Virtually on all the charts these levels are displayed by default, so once you introduce the indicator to your chart, you will see these lines.

You’re probably wondering what “overbought” and “oversold” mean? I will explain, avoiding complicated technical terms: if an asset is overbought, that means its price rose too high and it needs to come down. If the asset is oversold, its price has fallen too low and it must rise. Here’s how it looks on a chart:

overbought-chart

As you can see, once RSI comes into overbought zone (above 70), the price begins to fall, and as soon as it enters into oversold state (below 30), it starts to rise. In other words, RSI signals us a reversal movement, and in most cases identifies peaks and lows. When there is a pronounced trend, RSI is in the overbought/oversold for a longer period, so you stay away from accepting its signals and can buy options considering other indicators. Be patient and understand that this is just a tool and it cannot be used alone.

So, once you have learnt about the overbought/oversold, you should know that RSI is one of the best indicators to identify divergence. Yet this topic is difficult to understand for beginners and requires a longer time to explain in depth. Those who want to enhance their knowledge and skills can easily find online about the divergence in binary options.

What’s wrong with the RSI?

Nothing! This is one of the best indicators. Keep in mind that during a pronounced trend, there is a higher likelihood that the indicator will generate a false signal. But as mentioned above, do not rush to buy options in such a period and do not use the RSI indicator alone!

What’s great about RSI?

It is well known for its ability to predict price reversals. And the fact that this indicator has been known for a long time tells us that traders still successfully use it. RSI can show the strength of the movement, the potential completion of current movement, and the subsequent reversal in price. Moreover, with its help you can determine the divergence, and the level 50 is often used to confirm trend direction (RSI above 50 = upward trend, the RSI is below 50 = downtrend).

Conclusion

The potential of the RSI indicator is relative. This means that its effectiveness depends on the knowledge and skills of the trader who uses it. By itself, this indicator is very reliable, but it can cause inefficient trade decisions (as with any other indicator) if it is misinterpreted or if the trader does not see the wider picture and relies only on the RSI. A trader must learn how to use this tool to identify optimal signals.