RSI is one the most popular technical indicators whose operations everyone forex trader ought to understand.
Like most trend indicators, it tells you about a currency pair’s overselling or overbuying. Here is everything you should know about RSI to succeed with forex analysis.
What Is the Relative Strength Index?
Relative Strength Index (RSI) is a typical trend technical indicator used to analyze financial markets. It is displayed as a graph alternating between two extremes— 0 and 100.
It tells you, as a forex trader, the present and past price weaknesses and strengths of recent closing prices.
Forex technical indicators are pattern-based signals that a currency pair produces. The 4 main technical indicators are trend, volume, momentum, and volatility.
Trend indicators predict when currency pair prices will change based on historical data. Volume indicators show the number of sales and purchases made in a period.
Momentum indicators show the currency pairs’ rate of change. Lastly, volatility indicators signal the price quantity snowballing in a direction.
How Do You Calculate Relative Strength Index?
Use the RSI formula to calculate it. The formula is:
RSI = 100 – 100 / (1 + RS)
RS Stands for Relative Strength. Its formula is (Average gain /average loss) of all ups and downs. The average gain or loss is a percentage change in the look-back duration. The values are expressed as positives, whether it is a loss.
Before calculating RSI, you should decide the timeframe of your calculation. The most typical timeframe is the daily timeframe.
Secondly, you need to settle on the length of the computation. The length (N) echoes milestones you trace backward to determine the current prices’ RSI value. The most standard length is 14 days.
The steps for getting the equation’s values are:
- Calculate up moves and down moves.
- Average the up moves and down moves.
- Calculate RS.
- Get the RSI.
Finding Up and Down moves
First, get the daily price change as follows:
Up move (U): Closet – Closet-1 for the positive price change and zero for negative or zero recordings.
Down move (D): The absolute value of Closet – Closet-1 for negative changes, or zero if the resulting price change zero or positive.
Besides, an RSI calculator helps you in finding the Ups and Downs.
Average the Ups and Downs
Use Simple Moving Average, Exponential Moving Average, or Wilder’s Smoothing method, where N = RSI period, as follows:
Simple Moving Average
Average Ups (AvgU) = Get total of up moves (U) in the last (N) and divide by N.
Average Downs (AvgD) = Get the total of down moves (D) in the last (N) and divide by N.
Exponential Moving Average
AvgUt = α * Ut + (1 – α) * AvgUt-1
AvgDt = α * Dt + (1 – α) * AvgDt-1
α = 2 / (N + 1)
Wilder’s Smoothing Method
α = 1 / N.
After getting the averages, you can proceed and get Relative Strength as follows:
RS = AvgU / AvgD
And final compute the RSI using the RSI formula:
RSI = 100 – 100 / (1 + RS).
The computed RSI values help plot RSI curves that you see in trading platforms such as MetaTrader 4.
Understanding RSI curves and What They Tell You
The increase in positive closes makes the RSI rise. Likewise, losses cause the RSI to fall. An RSI closer to 100 denotes a strong trending market.
A reading below 30 signals a currency pair’s overselling, whereas those above 70 echo a market overbuying.
The indicator can stay in the overselling territory during an uptrend, or in an overbuying position to express a market downtrend.
What does an RSI of 50 mean? During the downtrend, the RSI peaks at 50% rather than at 70%. This signals bearish market conditions.