Relative Strength Index – Overview & Use in Forex Trading
Relative Strength Indicator
The relative strength Index is a standard indicator that Forex traders widely use in their analysis of the currency markets. It is one of the most closely watched of all hands in technical analysis as it can be used to identify those times when the price action of a currency pair is set to a pullback or temporarily reversed.
Relative Strength Indicator Use in Tech
The specific information plotted by the RSI (Relative Strength Index) is the rate of gain or loss in the valuation of a price in relation to its average rate of gain over a predefined time period. This measure is helpful for identifying those times when the market reaches a point of being overbought or oversold. It is these times that trader needs to focus on. They can form the basis of a successful trading strategy for foreign exchange pairs.
The indicator can be plotted on any trading chart and is usually set up to monitor the last fourteen days of price change. This setting can be used across several time chart periods, such as the fifteen-minute, hourly or daily chart. Most charting packages offer the core settings required, simply needing the indicator to be selected to enable you to get up and running.
A good strategy that can be used with this indicator is trading temporary reversals on the chart. Firstly you need to identify the dominant direction that the currency pair has been moving in the time frame you select. This can be done by using a Simple Moving Average. You can then use the RSI to identify times when the market has overstretched within this trend and trade the expected pullback.
An overbought level is signaled if the reading on the indicator posts higher than 80. An oversold level is indicated if the reading falls back below 20. Orders should be placed when either of these readings is reached. This strategy aims to enter the market against the primary trend and capture this pullback move. A suitable stop loss should be placed at the market high, and the target for the movement should be the first level of support or resistance below the current price.
It is important to exit the market quickly once the first objective has been reached, as the strategy is only designed to capture ‘counter trend’ moves. If the position is held for too long and the trader greedily eyes further profits, then they are in danger of getting caught out when the original trend of the Forex pair resumes.
