The relative strength index tells us how strong the market is
- Welles Wilder is a technical analyst who would always analyze and study charts. He developed technical indicators called “relative strength index,” which became widely used and popular among traders since it helps them evaluate and weigh how strong the current market is.
How does the relative strength index work?
If you are aware of stochastic oscillators and what they do, you may notice that they have a few similarities. Just like a stochastic oscillator, the relative strength index also tells us when the market condonation might be oversold or overbought. It also uses a scale that ranges from 0 to 100.
On this scale, if the reading says that it is 30 or even lower, it means that the market condition is oversold. And when we say oversold, we also mean that the possibility of the price getting strong increases or goes up. On the other hand, the opposite would be if the scale reading says that it is 70 or even higher, then it means that the market is oversold. And when we say oversold, we suggest that the possibility of the price getting weaker is increase or going down.
When the scale in the indicator says that the currency pair is oversold, most traders take this as a sign that the declining trend might reverse soon, so they think that this might be an excellent opportunity to buy. While if the scale on the indicator says that a currency pair is overbought, they will take this as a sign that the rising trend might reverse anytime soon, so they think this is an excellent opportunity to sell.
Relative strength index and crossovers
Here is more, traders use RSI not only when they need an overbought or oversold indicator but also as a centerline crossover indicator. Here is how it goes:
- Rising trend. RSI indicates a rising trend if the movement is below the centerline where the centerline is 50.
- Rising centerline crossover. It happens when it shows that the RSI value is above the 50 line and headed to the 70 line. When this happens, it also means that the market trend is getting stronger. It is a bullish signal until it reaches the 70 line.
- Falling trend. RSI indicates a falling trend if the movement is above the centerline, where the centerline is 50.
- Falling centerline crossover. It happens when it shows that the RSI value is lower than the 50 line and headed to the 30 line. When this happens, it also means that the market trend is getting weaker. It is a bearish signal until it reaches the 30 line.
Is RSI important?
Traders can use the RSI for different purposes. One way to use it is when picking tops and bottoms, but it depends if the market condition is oversold or overbought.
We can also use RSI when we determine trends. In fact, RSI is famous to traders when they want to confirm trends. If your hunch says a trend is coming, double-check with the RSI if it is above or below the 50 centerline. If it is above 50, then it might be a forming uptrend. If it is below 50, then it might be a forming downtrend. Be patient and wait for the RSI to cross below 50 to confirm the downtrend.
Simply, the relative strength index.
RSI is an indicator that helps traders create sound trading decisions through the scale. However, the scale might say overbought or oversold, but a trader should not always rely on indicators alone at the end of the day. They should also look at other factors and possibilities before buying and selling to avoid losses.