Trading with the RSI Indicator
If you are just getting into the world of trading then one of the most important things that you need to be able to master are indicators. When it comes to trading, indicators are extremely useful tools that can provide you with many different types of information. Ultimately, these indicators help you place the most profitable trades possible. What we’re here to talk about today is trading with the RSI indicator. The RSI Indicator is indeed one of the most popular and useful indicators out there.
Now, the fact of the matter is that although the RSI indicator is extremely useful and fairly easy to use, many people actually get it wrong. What we are here to do today is take a much closer look at the RSI indicator to see exactly what type of information it provides you with and how to use it. We also want to take a look at a big mistake that many traders make when using this RSI indicator, and how to avoid this mistake. We’re also going to provide you with many other useful tips for trading with the RSI indicator that you need in order to be successful.
What is the RSI Indicator?
The RSI indicator stands for the relative strength index. Now, in terms of what type of indicator it is, this is a momentum indicator. It was first created by a man named J. Welles Wilder. What you need to know here is that for this particular indicator is designed to measure the momentum or the speed of a price movement.
Some people might refer to this indicator as an oscillator because it oscillates between 0 and 100. What it means here is that the faster a price goes up, the higher that RSI value will be, and the other way around. In case you are wondering what the formula for calculating the RSI is, it is the following.
100 – 100/[1 + RS]
Keep in mind that for this formula, RS stands for the average gain/average loss.
How it Works
As you can see, the formula for the RSI indicator is actually fairly simple. We only slightly confusing thing might be the RSI calculation, which is of course the average gain divided by the average loss. What is important to note here is that the RSI indicator will go up when the average gain is very large, or when the average loss is very small.
Something that isn’t course important for you to know is how the value of the average gain goes up, and this is actually quite simple, so when the price of a security moves upwards very quickly and there are little or no pullbacks, the average gain is going to be very large because that price is making positive gains and that leads to a higher RSI value.
On the flip side of the coin, if the price falls very quickly and there are little or no pullbacks, the average loss is going to be very large because the price is making negative gains, and that leads to a lower RSI value. What is also very important to note is that both the average gain and the average loss can be easily manipulated by changing the settings of the relative strength index indicator. For instance, if you use a five period RSI, then the average gain, an average loss will both be based on the last five candles.
Therefore, what is important for you to know here is that the lower your RSI setting periods are, the more sensitive the indicator will be to recent price movements. Moreover, if you use a longer time period for the relative strength index, then the price will not be as sensitive to the motions and movements.
The RSI Mistake that Many Make
Something else that is important for you to know is that when the relative strength index is below 30, an asset is considered to be oversold. If the relative strength index is over 70, then an asset is considered overbought. So when the RSI indicates that an insecurity is oversold, many people think that the market can’t possibly go any lower, so they hit the buy button and go along.
Well, this can actually be a big mistake. This is because the RSI indicator actually measures the momentum of a market. It’s important to note that the RSI, if it is oversold, it signals that there is a strong bearish momentum, and if it is overbought then there is a strong bullish momentum.
Therefore, the big mistake that many traders make is blindly making a buy trade because there is strong bearish momentum or many people also hit the sell button because of the price seems way too high. The bottom line here is that don’t make the mistake of buying a security just because the RSI says that it is oversold, because the bottom line is that it can always be more oversold.
Using the Relative Strength Index to Win Trades
Technically speaking, the relative strength index indicator measures the average gain to loss ratio over a certain period of time to help determine the momentum in a market. A simple example of this is that if the relative strength index is above 50, it means that the average gain is greater than the average loss. So how exactly can you use the RSI indicator to help you win trades? Well, the bottom line is that the RSI indicator makes for an awesome trend filter that will provide you with information on whether you should buy or sell. Follow the examples as listed below in order to place the best profitable trades.
- A great idea is to adjust the period you are 200. So, you can easily identify the average gain versus the average loss over a very long period of time.
- If you see that the 200. Relative strength index is over 50, then the market is very likely in an uptrend, so you want to place buy trades, and on the other hand if the RSI is below 50, then the market is likely trending downwards, which means that you want to place sell trades.
Bottom Line on the RSI Indicator
Although there is of course a lot more information about the relative strength index, or RSI indicator, that you need to know, the bottom line is that we have provided you with a basic foundation of knowledge that you should be able to build upon. Keep in mind that the RSI indicator is one of the bold best momentum indicators out there, and it can help you enter trades with great confidence.
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