RSI, or Relative Strength Indicator, is one of the most common tools used by Technical Analysts. And is one of the most effective and reliable indicators. In this RSI indicator Cheat sheet, we will cover how you can use the RSI indicator to increase your profits, things to avoid while using the RSI indicator, And much more.
But first, let’s start with the basics.
What is the RSI?
The RSI is an oscillator indicator that measures the momentum and strength of price movements. It’s based on the ratio of up-moves to down-moves and is calculated as follows:
RSI = 100 – (100 / (1 + Up-moves / Down-moves)
The RSI values are between 0 to 100, with a reading of 70 or above indicating an overbought market and a reading of 30 or below indicating an oversold market.
To learn more about the basics of RSI, you can read this article- Relative Strength Index.
Avoid making this mistake when using the RSI indicator.
It is important to understand that RSI is a momentum indicator and measures the Strenth and momentum of price moves.
Suppose the 14-period( Daily Time Frame) RSI is trading below 30. The price in the last 14 days has dropped significantly, and the market is bearish and oversold. However, it doesn’t suggest that the market will bounce back soon, and just because it’s oversold does not mean it will move higher.
This is the most common mistake among traders; They think that it’s time to buy just because the RSI indicator is oversold. Or just because the RSI indicator is overbought, it’s time to short. However, It doesn’t work that way. The Indicator tells you that there’s an underlying trend in the markets. If it’s overbought, it’s telling you there is a significant bullish momentum. If it’s oversold, it’s telling us that there is a significant bearish momentum.
Use RSI as a Trend Filter
As discussed, RSI measures the momentum and strength in the price of a security. Let’s understand how you can use RSI to filter or identify the trend. The best way to do this is to change the RSI settings to a period of 200, which means that it will scan the last 200 candles to determine the average gains and average losses.
Now, if the RSI Indicator is above 50, it means that the average gain is more than the average loss, indicating the security is in a long-term uptrend. Similarly, if RSI is below 50, that means that the average loss is greater than the average again, indicating that the price of the security is in a long-term downtrend.
Note, When I use the term “long-term,” it’s a reference to the timeframe you’re looking at. If you’re talking about 200 candles in the 3-minute timeframe, this will be a long-term upward or downtrend for the timeframe of 3-minute candles. If you are doing this daily, it’s an ongoing uptrend or downtrend for your daily chart.
How to use the RSI Indicator to better time your entries
Suppose the RSI crosses above 30 after sustaining a long time in the oversold condition. It means that buying pressure may be back in the market, Which has caused RSI to cross 30. Now, this could be a good entry point for traders with bullish views of the market. And have witnessed bullish candlestick patterns or any other long signal. RSI can be used as a reliable entry trigger.
It is important to note that this is just an example of an RSI signal when all other requirements are met, not a trading strategy itself. Although using RSI for generating buy and sell signals can greatly complement your strategies.
How to use the RSI indicator to capture a swing
Swing trading is a trading style where traders look to capture short-term price moves. But what does capturing a swing means?
While swing trading traders look to buy at the bottom and sell at the top, Imagine that the market is in range. A trader typically looks to buy at Support and Sell at the Resistance, and RSI can help you capture complete swing trades.
Suppose, You took a short position near a Resistance zone, according to your trading setup, which means you have captured a Swing or a move in the market. RSI can help you exit at the right time.
You can Square off your position when RSI crosses below 50 since RSI has crossed below 50. It means the market has already moved one move lower, and the swing is completed.
And Since your motive as a swing trader was to capture a swing. You can square your position.
The Relative Strength Index, or RSI, is a momentum indicator that measures the speed of price moves. To avoid making incorrect decisions, do not buy solely on an oversold RSI reading or short solely on an overbought RSI reading. To increase your winning rate using the RSI indicator, consider using RSI as a trend filter. The Indicator can also be a valuable tool to capture swing trades. And triggering buying and selling signals when used in conjunction with existing trading strategies.