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Sunday, April 15, 2012

RSI – How Do You Do

Sometimes, review is a good thing. Thus, I pulled this from my vast archives of writing because it speaks to a volatile market (it pertains to equity as well as forex trading), much like the one we now are in, again …

Another week in the market is now under our belt.  Although, I can’t complain, as things have been going my way, I can say that I hope the economy stabilizes sooner rather than later, which I guess puts me in the company of, oh, just about everyone else in America.  Be that as it may, I do have the question below to answer, and so I will …
I am new in forex the field.  I learned that if RSI is above 70 than I should sell, and if it is below 30 than I should buy.  Mostly, though, the RSI seem to remain in the 40, 50, 60 range most of the time.  What should I do at these points?
The first thing I will tell you is that one indicator does not a trade make.  If you are relying just on RSI (Relative Strength Index), then you are making a mistake.  
Generally, indicators work in combination with other indicators to both find and confirm potential trades.  Thus, the RSI only has meaningful value when compared with other indicators, if you ask me, and you did.
Second, even if you rely solely on the RSI, or if you do use it in combination with other indicators, the 70/30, buy/sell “rule” is not a rule at all; it is a guide.  
Generally, when in the 70 range, a market is considered “overbought.”  When in the 30 range, a market is considered “oversold.”  But even though the readings may be such, you should consider other factors in the RSI, such as the timing of the move into either the 70 or 30 range, how long the indicator has remained within either range, and the general volatility of the market itself during the trading time you are viewing.  Outside of the RSI, in my opinion, two of the best indicators to use in combination with the RSI are MACD (Moving Average Convergence Divergence) and Stochastic.  Both indicators give information on momentum, which allows you to compare with what the RSI is telling you (See the chart below.).  
Note how all three indicators are telling almost the same story – the market has enjoyed certain stability and a bit of an upturn.  The RSI, however, suggests that that the “run” may be over.  The other indicators, although not as definite as the RSI, suggest the same.
As to the notion that in forex, the RSI seems to be in the middles ranges most of the time, I really don’t have much to say to that, other than you just might need to spend a lot more time watching the charts.  Where the RSI goes is wholly dependent on the price action of the market, and in these days of high volatility, I would think the forex markets would spend at least as much time in the 70/30 range as they spend in the middle range.  As to what you should do when the RSI is in the middle range … Well, I guess that just depends on your strategy.  You do have a strategy, right?
Trade in the day; invest in your life …
Trader Ed