Although currency prices in the Forex market may be volatile, they generally repeat themselves in cycles, creating trends. The trends can be analyzed by traders using technical tools. Oscillators are considered leading indicators and typically turn before price reversals. They are primarily used in lateral price movement.
Oscillators are considered leading indicators and typically turn before price reversals. They are primarily used in lateral price movement. However, if we get into the market situation, where the instrument trends, the oscillator still gives us signals to sell or to buy, but most of them are false. The group of oscillators includes Stochastic, RSI, Momentum, Williams’ Percent Range, Rate of Change, Commodity Channel Index and Bollinger Bands.
Relative Strength Index (RSI)
W. Wilder is the author of the popular RSI indicator and he introduced other popular indicators in business practices, such as Directional Movement Concept, True Range or Volatility Index and the Parabolic Stop and Reverse. RSI is included in all software products intended for technical analysis, and everyone, even the simplest charting tool on the Internet can provide it. Oscillators are derived from the underlying currency to provide signals regarding overbought and oversold conditions. Since the market fluctuates, prices tend to overshoot or overextend. The most common oscillators are described below.
Calculation of RSI indicator
Relative Strength Indicator is used to measure the strength or momentum of a currency pair. This indicator is calculated by comparing a currency pair’s current performance against its past performance. To calculate a single indicator we need only one variable, and that is the period which we will use for the calculation. Period is again meant last lines on the chart. Period 14 will therefore use the 5 minute charts, RSI values will be calculated on the basis of the last 14 five-minute segments, period 14 in the daily chart will the RSI values calculate on the basis of the last two trading days. The formula for calculating the RSI indicator is as follows:
RSI = 100 – 100 / (1 + RS) RS = (average number of lines that conclude higher than the previous segment) / (average number of lines that entered below the last segment)
If we wanted to get the current value of the RSI with a period, say 14, then we would have to proceed as follows:
1. Count how many of the last 14 lines have the close value above the previous close lines. Then we have to divide this number by the number fourteen.
2. Count how many of the last 14 lines have the close value below the previous close lines. Then we have to divide this number by the number fourteen.
3. Divide the value from the bullet no. 1 by the value of value of the bullet no. 2, thus we will obtain the value of RS.
4. Count the current RSI as 100 – 100 / (1 + RS). As a result we obtain a value between 0-100.
How to Trade Forex with the RSI Indicator
There are many ways how to use a RSI indicator. The basic way of buying is when the RSI curve exceeds 20 upward or sell when the RSI curve exceeds 80 downwards (some traders use values between 30 and 70).
An RSI above 70 indicates an overbought condition, which in turn indicates a sell signal. An RSI below 30 represents an oversold condition, which implies a buy signal. Moreover, a sell signal is indicated when the market price is high and the RSI value begins declining. Conversely, a buy signal is indicated when market price is low and the RSI value begins to rise.