Forex Charts: The Relative Strength Index

The Relative Strength Index or RSI is a very popular indicator that can be used to identify oversold and overbought markets on forex charts. It is a momentum oscillator developed by Welles Wilder that compares the size of a currency's recent gains to the size of its recent losses and expresses this as a number between 0 and 100.

In most cases, a reading of less than 30 indicates an oversold market and a reading of over 70 indicates an overbought market. Some traders prefer to wait for a stronger signal by setting the marker lines at 20 and 80. Crossing these lines can be used as a buy and sell signal respectively.

The RSI can also be used to identify or confirm trend formation at a glance. There is a center line at 50. If you consider that the market may be on the point of forming a new uptrend, take a look at the RSI and check that it is above 50. This is a bullish signal, indicating that average price gains are higher than average losses. In the same way if you suspect that a downtrend is forming, check the RSI shows below 50.

When we talk about trends here, of course we are not looking at short term fluctuations in the market. These trends may last for several months. So this is not a tool for day traders.

The RSI is a running calculation that relies for its accuracy on the number of past time periods that are used in the calculation. Depending on your charting package you may be able to vary this parameter. 14 is generally the minimum. Increasing this number will improve the accuracy of the RSI but will mean that it does not pick up on a new trend so early. So you have to balance the advantage of getting in on a new trend near the start, with the disadvantage of sometimes opening a trade on a false signal.

The RSI is a very popular tool because it gives the trader so much useful information in such a simple form. If you start using regularly you will probably find that it pays off. Indeed, it may be tempting to rely only on RSI for your signal to enter the market. However, it is never wise to depend on only one indicator. They all have their failings and will let you down when you least expect it. You should always confirm your findings by checking with the stochastic or another indicator on your forex charts.