Adding the RSI to your entry or exit decision-making
The Relative Strength Index (RSI) is an oscillator type of indicator, designed to illustrate the momentum related to a price movement of a currency pair or CFD.
In this brief article we aim to outline what this indicator may tell you about market sentiment, and along with other indicators assist in your decision-making.
As with most oscillator type of indicator, the RSI can move between two key points (0-100).
The major aim of the RSI is to gauge whether a particular asset, in our context a Forex pair or CFD, is overbought or oversold, and the associated key levels are below 30 (when it is classed as “Oversold”) and above 70 (where it is classed as “overbought”).
To bring up an RSI chart on your MT4/5 platform it is simply a case of finding the RSI in your list of indicators in the Navigation box and clicking and dragging it into your chart area.
The diagram below illustrates this on a 30-minute chart.
It is generally thought that if the RSI moves into either of these two zones then a change may be imminent.
Most commonly the RSI may be used as part of entry decision making. Traders may use this as an additional tick (when other indicators suggest entry) to make sure they do not enter a long trade on an overbought currency pair, or short trade on an oversold currency pair.
Therefore, when articulating this in your trading plan it may read something like the following:
a. I will refrain from entry into a long trade if the RSI has moved above 70 on the last trading bar.
b. I will refrain from entry into a short trade if the RSI has moved below 30 on the last trading bar.
Less frequently but logically, if one accepts this premise that a move into either of the previous described zones then a trend change may be imminent. It could also be used as a “warning” to potentially exit from an open trade. Traders who wish to explore this in their own trading could:
a. Tighten a trail stop to within a specified number of pips from current price e.g., 10 Pips. or
b. Exit the trade entirely.
Of course, in either case and with any indicators we discuss, back-testing it with previous trades to ascertain any change in outcomes can be performed to justify a prospective test. Finally, after gathering a critical mass of trade examples exploring if this would make a difference, this could provide the evidence to suggest whether you should (or should not if there is no difference) formally add to your trading plan.
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This article is from GO Markets analysts based on their independent analysis. Views expressed are of their own and of a ‘general’ nature. Advice (if any) are not based on the reader’s personal objectives, financial situation or needs. Readers should, therefore, consider how appropriate the advice (if any) is to their objectives, financial situation and needs, before acting on the advice.