The Relative Strength Index is one of the most popular technical indicators. It belongs to the group of oscillators, the so-called momentum indicators.
Oscillators mostly generate countertrend signals in the sideways channel. RSI is also used as a trend indicator by some trading algorithms. The RSI indicator shows the current price position in one of three zones: in the overbought zone, in the trading channel or in the oversold zone.
By default, the overbought zone is displayed on the indicator above 70%, and the oversold zone is below 30%. The main variable in the RSI formula is the time frame, which is 14. The time frame can be changed if necessary (due to one’s trading strategy or market volatility).
The longer the time frame, the more sluggish the indicator. And it also loses its sensitivity to price movements. The recommended parameters for the time frame are 5.14 and 21.
There are several options for defining entry points using the RSI indicator. One of the best entry points is to wait until the trend reverses, for example from the oversold zone, and crosses the 30% mark.
In other words, we do not trade against the trend (because it is often dangerous), but we get the entry point to trade long as a new trend has already reversed, as shown in the illustration below. We will get the entry point to trade short after the breakout of 70% mark and leaving the overbought zone. The recommended expiration time for transactions is 1-2 candles.
An important characteristic of any oscillator, including RSI, is that it can signal a possible trend reversal. The moment when indicator signals a fall, but the price continues to increase or it is at the same level (ie, a divergence occurs) is a clear sign that the trend is growing weaker. In this case, you need to be prepared for the beginning of an opposite trend.
When trading divergence, one should remember that the opposite trend may not begin soon, so the options expiration time should be from 5 to 10 candles. Also, keep in mind that a divergence does not occur often, and an inexperienced trader will need time to start differentiating it on the chart.
Using the indicator
In order to get more accurate signals, we recommend to combine the RSI indicator with other technical analysis tools. It is perfectly used with price levels and candlestick reversal patterns.