RSI: if too much is bought or sold
An indicator of binary options the Relative Strength Index (RSI) is one of the most popular tools for market players. It was created in 1978 by a trader Welles Wilder. The world learned about it after the publication in the magazine Commodities. Wilder was fond of earning money in financial markets. He’s the author of several unique tools for forecasting the market. The index of relative strength appears to be his most famous creation.
The most popular indicators developed by Wilder include Parabolic SAR, Average True Range (ATR) as well as Average Directional Movement Index (ADX). These classic tools are not only widely utilized by traders, but they’re also an essential element of a number of productive trading strategies. By the way, the RSI shouldn’t be confused with relative strength, which compares security performance with the overall average of the market or index (for instance, the Dow Jones Industrial Average).
The basics of the RSI
The RSI relative strength index is one of the technical indicators, widely known as inertia oscillators. Such popular pulse generators are MACD as well as Stochastic Oscillator. The very principle of the indicator is that it compares the absolute values of growth and decline of the market for a certain period of time. It determines the trend’s strength and the probability of its change. The popularity of the RSI can be explained by the simplicity of its interpretation. The chart of the indicator repeats the price chart, the price lows actually correspond to the minimums on the RSI chart, while the price highs correspond to the RSI maximums.
The RSI gauges the speed and magnitude of the price movement, displaying the data between 0 and 100. The indicators are calculated based on the data on the average profit and loss from the asset for a specific period of time. The very fact that the RSI reading fluctuates from 0 to 100 helps to highlight the fixed areas of overbought and oversold. The main parameter of the indicator setting is the period. By default it’s 14, although it can be changed depending on the strategy. When the index decreases, the sensitivity of the indicator increases, generating more signals of overbought and oversold; when the index of the period goes up, the sensitivity slumps, fewer signals are available.
RSI = 100-100 / (1 + RS)
Overbought and oversold signals
The most popular way to use the RSI is to search for overbought or oversold areas:
- If the indicator is above the 70 mark, it’s an overbought signal;
- If the indicator chart is within 30, it’s an oversold signal.
That’s how the RSI shows the dominant forces of the market:
- If the indicator is above 30, it’s a bullish trend (uptrend) indicating the strength of buyers in the market;
- If the indicator chart is below 70, it’s a bearish trend (downtrend), indicating the strength of sellers in the market.
As with other pulse oscillators, the overbought and oversold signal works best of all not during the trend, but in lateral price movements. The indicator is common in trading strategies as a reliable trigger for determining the optimal entry and exit area.
The author of the indicator ascertains that the discrepancy between the price chart and the oscillator readings of the RSI point to a potential reversal. Signals of divergence and convergence occur quite often. They arise when the price chart is not supported by the indicator. Such discrepancies, appearing in the moments of a trend: ascending or descending, always warn about the imminent end of the trend.
Divergence is a bearish signal that occurs on an uptrend when the price sets new peaks, while the indicator doesn’t In this case, you need to buy a CALL-option.
Convergence is a bullish signal that occurs on a downtrend when the price sets new lows, while the indicator does not. In this case, you need to buy a PUT-option.
Signals of divergence and convergence in the RSI
Bullish discrepancy occurs when the underlying asset is in the lower minimum position, while the RSI, on the contrary, is at a high minimum. The RSI reading diverges with the bearish trend of the price chart, showing a strengthening of the momentum and, as a result, a potential upside-down in the price.
Bearish discrepancy occurs when the underlying asset is in the maximum position, and on the contrary, the RSI chart forms a lower maximum. The RSI reading diverges with the price signals, showing a weakening of the momentum, and as a result, a potential reversal in the price.
The most popular indicators indicating signals of divergence and convergence are the RSI, Stochastic, MACD. The search for these signals is a profitable strategy, simple and effective. To obtain reliable signals, it’s highly recommended to make use of several indicators.
Illustrating the possibilities of the RSI, Wilder pointed to another indicator of the potential price reversal. It’s the failure oscillation, which takes place in case of :
- a failed bullish swing of the pattern when the RSI first moves below 30, then rises above 30 and pulls again, staying above level 30. Such a failed swing will be completed when the RSI line breaks its maximum – this breakout appears to be a bullish signal.
- a failed bearish swing of the pattern, when the RSI is above 70 at first, then drops below 70 and rises again, staying below the 70 mark. Such a failed swing will be completed when the RSI line breaks its minimum – this breakout is a bearish signal.
How to use data mismatches
The RSI generates reliable signals of market conditions, but still it’s worth remembering that the indicator can give false signals, so it’s advisable to make use of the signals of other oscillators for greater reliability. However, discrepancy of the RSI data can be applied in the trend market:
For example, during a strong uptrend, the RSI can only move between levels 40 and 80. Falling to a mark of 40, the indicator will point to a bullish reversal area (resumption of the uptrend), while level 80 can be viewed as an overbought area. Also, with a strong trend decrease, the RSI can be between 60 and 20. Here, the level 60 can be considered to be a potential downward reversal area (resumption of a downtrend), while the level 20 can be viewed as a resold area.
Trend line breaks
Using trend lines with an indicator is a simple and effective strategy. In this case, thanks to the RSI, you will receive breakout signals much earlier than the price chart.
With an uptrend trend, the trend line shows a progressive upward movement, in which higher lows and maximums are formed. When one of the lows is broken, it indicates a possible trend reversal. It also occurs with a downward trend.
Applying the trend lines on the very oscillator RSI, it is necessary to remember about possible breaks above or below the lines, which will demonstrate the potential change of the market trend.
The most important thing is that the breakthrough of the support line will be a good signal of the price reversal. When making the use of the RSI, you shouldn’t limit yourself to signals of overbought and oversold, which are considered to be more risky deals. It is worth paying attention to the fact, whether the trend is formed by the RSI line, and where trend lines are broken – this can give good warning signals of the trend change.
Trading with the RSI with the broker FinMax
The RSI indicator is presented in most modern trading platforms. We recommend using its capabilities with a proven FinMax broker. To do this, you only require going to finmaxbo.com. On the main page you can add the RSI to the chart by clicking on the tab with indicators:
After the indicator is added to the chart, you can start working with it:
If the RSI line is located at the 70 mark, we have the overbought zone – that’s the signal for the sale of the PUT option. In the picture below you can observe the downward trend of the market on the broker FinMax platform:
You are welcome to place a PUT (down) option at the Finmax broker. To do this, go to the finmaxbo.com broker’s website and prepare an option:
- The amount
- Direction forecast: DOWN
- Then click on the “buy” button and wait for the forecast results.
If the RSI value is at 30, this is the oversold zone and the signal to buy the CALL option. In the picture below you can observe the upward trend of the market on the broker FinMax platform:
The Finmax broker offers you to place your CALL-option (up). To do this, visit the finmaxbo.com broker’s website and prepare an option:
- The amount
- Direction forecast: UP
- After this you should click on the “buy” button and wait for the outcome of the forecast.
Advantages of the RSI
Despite the fact that the RSI is more than 40 years old, it’s still relevant today. In spite of the fact more indicators, especially modified ones, show up, the RSI is a typical example of the tool, which is very difficult to replace with any modern oscillator. It works perfectly with the side flat and also in various strategies.
Moreover, it’s easy to use. It’s available for both of professional market players and newcomers. With proper use, the RSI will give clues as for the potential trend reversal. As an element of your profitable strategy, it’s capable of generating high quality signals, which will bring you a good income.