How to use RSI effectively in Trading
By Deya Hroob
Relative Strength Index (RSI) is a well-known technical indicators among traders. However, some of traders use it in a traditional way or use it wrongly. In this topic we will cover some profitable ways to use RSI.
What is RSI?
Relative Strength Index (RSI) was developed by J. Welles Wilder in 1978. It is a momentum indicator that measures the speed and
change of price movements. Many traders use it to spot the overbought
and oversold state of the market to initiate long or short position.
The readings of the indicator fluctuate between 0 and 100. The RSI is considered overbought when above 70 and oversold when below 30.
How to use RSI profitably?
1) Chart Pattern
There are numerous chart patterns like Head and Shoulders, Double Tops , Pennants , Flags and many more. We see them forming in price charts. Amazingly, they are also forming in RSI even if they don't show up in price charts.
Let's take an example:
This is AUD/JPY daily chart. We can notice an inverted head and shoulder pattern formed on RSI that doesn't appear on the price chart. In such pattern, traders should buy on a breakout of the neckline.
I want you to look very carefully to the price chart. When a breakout of the neckline happened on RSI, the price was trading below stiff resistance, nevertheless traders took the RSI signal and the pair surged more than 400 pips.
If we had taken this trade, we'd have ended with huge profit.
Let's take an example:
This is AUD/JPY daily chart. We can notice an inverted head and shoulder pattern formed on RSI that doesn't appear on the price chart. In such pattern, traders should buy on a breakout of the neckline.
I want you to look very carefully to the price chart. When a breakout of the neckline happened on RSI, the price was trading below stiff resistance, nevertheless traders took the RSI signal and the pair surged more than 400 pips.
If we had taken this trade, we'd have ended with huge profit.
Let's take another example:
This is WTI Crude Oil daily chart. If we look at the RSI, we will clearly see a Double Bottom pattern which doesn't appear in the price chart.
We would have traded this on a breakout on the RSI and made 10% profit.
2) Divergence
There are two kinds of divergence
a. Bearish divergence : occurs when price forms higher highs while the RSI forms lower highs.
b. Bullish divergence : occurs when price forms lower lows while the RSI forms higher lows.
The divergence between price and RSI warns us of the market reversal.
Let's take an example:
In the chart below, the RSI formed a lower high while the price formed a higher high on the OIL daily chart. It's a bearish divergence,thus, a short position should be taken with stop loss placed above the higher high on the price chart.
After this trade, Oil dropped more than 20%.
Let's take another example:
In the chart below, the RSI formed a higher low while the price formed a lower low on the ETHUSD daily chart. It's a bullish divergence,thus, a long position should be taken with stop loss placed below the lower low on the price chart.
After this trade, ETHUSD rose a 100%.
Also,in the chart below, the RSI formed a higher low while the price formed a lower low on the AUD/USD daily chart. It's a bullish divergence,hence, a long position should be taken with stop loss placed below the lower low on the price chart.
After this trade, AUD/USD rose 150 pips.
3) Trend Lines
They provide us with support and resistance points where we can buy or sell. Most importantly, many traders look for Breakout and Breakdown of the trend lines as they give us huge potential profits. You should go long on Breakout and short on breakdown. In this article we will look for trend lines that show up on the RSI not on the price chart.
Let's take several examples to demonstrate this:
Firstly, this is WTI Crude Oil daily chart. If you look at the RSI, you will notice that there is a breakout of a bearish trend line.This is a bullish sign. After the breakout on the RSI, oil went up 10%.
Below is a daily chart of Gold. As you can see the resistance line on the RSI was broken and this is a sign to go long on this trade. Gold rose sharply after the breakout.
And finally we get back again to Oil chart. If you look at the RSI , you can see the support line was broken down. This is a bearish sign. If you had taken this trade, you would have ended up with 20% profit.
Although there is also a breakdown on price chart but the signal came earlier from the RSI.
This is WTI Crude Oil daily chart. If we look at the RSI, we will clearly see a Double Bottom pattern which doesn't appear in the price chart.
We would have traded this on a breakout on the RSI and made 10% profit.
2) Divergence
There are two kinds of divergence
a. Bearish divergence : occurs when price forms higher highs while the RSI forms lower highs.
b. Bullish divergence : occurs when price forms lower lows while the RSI forms higher lows.
The divergence between price and RSI warns us of the market reversal.
In the chart below, the RSI formed a lower high while the price formed a higher high on the OIL daily chart. It's a bearish divergence,thus, a short position should be taken with stop loss placed above the higher high on the price chart.
After this trade, Oil dropped more than 20%.
In the chart below, the RSI formed a higher low while the price formed a lower low on the ETHUSD daily chart. It's a bullish divergence,thus, a long position should be taken with stop loss placed below the lower low on the price chart.
After this trade, ETHUSD rose a 100%.
Also,in the chart below, the RSI formed a higher low while the price formed a lower low on the AUD/USD daily chart. It's a bullish divergence,hence, a long position should be taken with stop loss placed below the lower low on the price chart.
After this trade, AUD/USD rose 150 pips.
3) Trend Lines
They provide us with support and resistance points where we can buy or sell. Most importantly, many traders look for Breakout and Breakdown of the trend lines as they give us huge potential profits. You should go long on Breakout and short on breakdown. In this article we will look for trend lines that show up on the RSI not on the price chart.
Let's take several examples to demonstrate this:
Firstly, this is WTI Crude Oil daily chart. If you look at the RSI, you will notice that there is a breakout of a bearish trend line.This is a bullish sign. After the breakout on the RSI, oil went up 10%.
Below is a daily chart of Gold. As you can see the resistance line on the RSI was broken and this is a sign to go long on this trade. Gold rose sharply after the breakout.
And finally we get back again to Oil chart. If you look at the RSI , you can see the support line was broken down. This is a bearish sign. If you had taken this trade, you would have ended up with 20% profit.
Although there is also a breakdown on price chart but the signal came earlier from the RSI.
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