Learn Forex – RSI as a Forex Trend Indicator
(Please click on the forex chart thumbnail to enlarge)
Learn Forex (FXpath.com) – Many forex traders think of the Relative Strength Index (RSI) as just a simple chart oscillator that gives momentum readings of overbought/oversold conditions during trading ranges, as well as price-oscillator divergence indications. Actually, the RSI is somewhat more than that.
One of the most popular indicators/oscillators in existence, the RSI was introduced by J. Welles Wilder in his 1978 book, New Concepts in Technical Trading Systems. Its formula is simple enough. Mathematically, it is just a comparison of the magnitude of recent gains to recent losses. Many traders and analysts just stick with its oft-used default period setting of 14, but any other setting can readily be used according to one’s experimentation/testing. The vast majority of technical traders and analysts that use RSI simply have it on their charts as a confirmation tool for momentum readings during ranging markets as well as divergence indications, as mentioned.
But during trending markets, the RSI can also serve as a very useful indicator. Innovative technical analysts have made certain observations regarding the RSI during trends. Perhaps the most important of these observations is that during uptrends, the RSI often consistently fails to reach down to the oversold area (below 30), while succeeding in reaching far into the overbought area (above 70). Conversely, during downtrends, the RSI also often fails to reach up to the overbought area (above 70), while succeeding in reaching far into the oversold area (below 30). The accompanying EUR/USD daily chart helps illustrate this point. This is a readily observable phenomenon that can be measured with simple horizontal lines well above the 30 level and well below the 70 level. The RSI oscillator’s tendency to do this can help both in evaluating the strength of a trending market as well as in identifying entries into a trending market.
How can trend-trading entries be identified using this RSI characteristic as a tool? This can be accomplished in much the same manner that Woodie’s CCI Club uses the Commodity Channel Index (CCI) oscillator to identify “zero-line-rejects”, or bounces off the zero-line that represent pullbacks within a trend. RSI users can consider bullish bounces that occur above the oversold line as potential pullback entries within an uptrend, or bearish bounces that occur below the overbought line as potential pullback entries within a downtrend. In this way, the often overlooked RSI can become an important tool for any forex trader looking to identify and potentially capitalize upon the frequent trends that occur in the forex market.
James Chen, CTA, CMT (bio)
- Click here for my book, Essentials of Foreign Exchange Trading (Wiley).
- Click here for my book, Essentials of Technical Analysis for Financial Markets (Wiley).
- Click here for my video DVD set, High-Probability Trend Following in the Forex Market (FXstreet).
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Comments
Hi James
I enjoy very much your insight of trading as well as postings.
Regarding the RSI, what are the parameters you can advise for Daily and H4 time frames trading?
Thank you for your time.
Warmest Regards
T. Pat
Hi Chua,
Thanks for your question. Actually, yes, many people view RSI and other oscillators as better-suited for ranges than for trending situations. This articles presents another perspective, that RSI can be used very effectively to identify and trade trends. For ranging situations, most traders who use RSI use it to give readings of momentum (overbought/oversold) as well as price-oscillator divergences. Hope that helps!
James Chen
Hi T.Pat,
Thanks very much for visiting and for your comments. To answer your question, different traders use a wide range of different settings. However, what I use, and what many RSI traders tend to use and recommend, is the 14-period RSI. I generally use the daily and 4-hour timeframes. When I am using RSI, I will keep the setting at 14 periods for both timeframes. Hope that helps. Thanks, T. Pat!
James Chen
Hi james,
Question so normally you use RSI reading 70/30 to do trades? Any other indicators recommend to use wif RSI? And whats “zero-line-rejects”?
Hi Arc!
Thanks for your questions, and sorry about the late reply. To answer your questions, yes, I normally stick to 70/30 for overbought/oversold when I use RSI. As for other indicators, I also use Stochastics and moving averages. But much of what I do revolves around price action, trend, and support/resistance. Zero-line rejects are patterns originated by the trader, Ken Wood, who trades almost exclusively on the CCI indicator. This pattern occurs when the CCI bounces off or near the zero line on the indicator. Hope that helps! Thanks, Arc!
James Chen
Thanks james for the reply. So basically CCI works like the STO buysell at 100/-100 and when the line hits zero stop all trades? Is that correct?
Hi Arc,
Once again, sorry for the late reply. As for your example, it doesn’t work the same way, at least for the zero-line reject approach. If you would like more information on how Woodies CCI Club works with the CCI, take a look at their website: http://www.woodiescciclub.com/index.html . Hope that helps. Thanks, Arc!
James Chen
somebody told me that the best frametime to use RSI is 15min,is that true,and can we use with other timeframe like 1h,2h,4h,daily or weekly? thx in advance
Hi Joe,
Thanks for visiting and for your question. You can absolutely use RSI on other timeframes, including all of the ones you mentioned, and more. RSI is not timeframe-specific. And I don’t think that RSI works better on 15 minute than on other timeframes, although the person that told you that may have some strategy that he/she uses with RSI that works especially well on 15-min. But I am not aware of such a strategy. Hope that helps. Thanks, Joe!
James Chen
thx 4 ur response, my question now is u as a trader whatis the best time frame u use it wth RSI,and do we have to wait until 70 or 30 to get in the trade?
Hi Joe,
Thanks for your follow-up question. If you would like to know what timeframe I use, I generally stick to daily, 4-hour, and 1-hour charts. And I would use RSI on all of these timeframes, or Stochastics. As for waiting for 70 or 30 on RSI before getting into a trade, that’s one strategy that some traders use. However, if you read the article above, I mention that in trending situations, the RSI often fails to reach 70 or 30 (depending on the direction of the trend). So if you are trading RSI using this approach, you wouldn’t wait for 70 or 30 on RSI. Hope that makes sense. Thanks, Joe!
James Chen
Thanks fr sharing this information. These are also three trend indicators Moving average, Bollinger Bands, ADX.
Good tips…but would RSI suitable to be used in ranges?