There are so many technical indicators available to the trader today and for some, choosing between them is a nightmare. When you are considering using the RSI as your momentum indicator, for long trades, you would want the indicator to be above 50 on all time frames, and for short trades, you would want it to be below 50 on all time frames. Momentum indicators are best when your strategy involves following the trend.
How does the RSI work?
The RSI measures how many of the set amount of candles close up, or down, and then give you a score between 0 and 100. If for instance, set period is 5 candles and all 5 the previous candles closed higher than they opened, the RSI would give you a score close to 100, when they closed lower than they opened, a score close to zero, and if the market ranged in the same position a score of 50.
The RSI is a momentum oscillator and simply tells who is in control, the bears or the bulls.
There are 3 parts of the RSI you should be aware of:
- Above 70 – Overbought
- Crossing 50 – Indication that momentum is changing
- Below 30 – Oversold
This simply means, when the RSI is above 70 you would generally expect it to fall when it breaks below 70, this would be confirmation the market is changing down.
The same applies to the 30 line, below it, the market is oversold, and you would expect it to rise, when it breaks through 30 you will have confirmation the market is changing up.
When the market crosses the 50 line, it is an indication the momentum is beginning to change in the direction of the break.
Although all of this sounds pretty easy, many rookie traders have blown their accounts using this indicator without understanding it properly.
How to trade with the RSI
When developing a trading strategy you have a couple of options:
- Following the trend
- Fading the trend
- Range Trading
When following the trend:
When the RSI crossed from below 50 to above this is a signal that a bullish trend may be starting.
When the RSI crossed from above 50 to below 50 it is a signal a bearish trend may be starting.
When Fading the trend
When the RSI crosses from above 70 to below 70, it indicates the bulls are losing control of the market and the bears are ready to step in.
When the RSI crosses from below 30 to above, it indicates the bears are losing control of the market and the bulls are ready to step in.
Always look for a confluence of factors
As a trader, you should know there is no way to predict the future. The best we can do is looks for setups with the highest probability of success. Trends can go on for years, and even these strong trend can come to an end in an instant. Use the RSI in conjunction with other indicators such as the MA 200, support and resistance or other analysis methods to develop a high probability strategy and always backtest your strategy before trading it.