This educational material is courtesy of IQoption broker. Find out more here.
General Risk Warning: The financial services provided by this website carry a high level of risk and can result in the loss of all your funds. You should never invest money that you cannot afford to lose.
Video guide – RSI:
The RSI
The RSI is one of the most popular oscillators which perfectly works in different market conditions and helps us to define exact entrance points.
Why do we need it?
- Defines the reversal/pullback points.
- Defines the trend strength.
How to use it?
- Choose the “Relative Strength Index” from the list of indicators.
- Without changing the settings, click “Apply”
How does it work?
The RSI (Relative Strength Index) is a technical indicator and an oscillator following the price movements that range between 0 and 100. The RSI belongs to a group of the most popular oscillators. It is equally good for the market trends and the sideways moves. The RSI compares the latest asset price rise to the price fall and provides this information as a figure in the range from 0 to 100.
Overbuy (the indicator level is above 70%) – the market went up above the normal level and we are expecting the price will move down soon.
Oversell (the indicator level is below 30%) – the market went down below the normal level and we expect the price will move up soon.
The RSI Strategy
- Apply the RSI indicator to the chart and choose a 26-period setting.
- Wait for a moment when the indicator clearly shows overbuy or oversell:
- Overbuy – the indicator level is above 70% a trend reversal signal for buying the put option.
- Oversell – the indicator level is below 30% a trend reversal signal for buying the call option.
Advanced usage
Advanced application of the indicator:
- Divergence. The divergence signal is received in case of discrepancy between new highs or lows on the oscillator chart and the price. If the new high on the oscillator chart is below the previous one, while a new high on the price chart is above the previous one, we see a discrepancy between the oscillator and the price. This signals an upcoming uptrend reversal and subsequent sales. 2. Graphic patterns. Graphic patterns are often formed on the RSI chart (classic patterns) and are used by the traders for analyzing the price charts.
- Graphic patterns. Graphic patterns are often formed on the RSI chart (classic patterns) and are used by the traders for analyzing the price charts.
- Support and resistance levels. on the RSI are often more clear than those on the price charts. Defining points following the max and min values of the oscillator.
Divergence + RSI
The problem of most technical indicators is the fact they are lagging. It happens because the calculation formula is attached to an instrument price, that is when the price starts rising, momentum makes the indicator move higher and vice versa. Therefore, false signals and delays are emerging.
An effective way to get over this disadvantage is to use the divergence effect. Divergence occurs when there is a discrepancy between the price and the technical indicator, in brief, this is an indicator denial to confirm a higher price high. The price divergence is a reversal model, and for its detection, the oscillator type indicators, like the RSI, are used.
Simple work layout:
- Apply the RSI indicator to the chart with a “21” period adjustment.
- Search the divergence between the current price direction and the indicator direction.
In the sample, after rising, the price formed a new high (1), at the same time, the RSI oscillator refused to follow the price and showed weakness (2). This is the divergence in its display, it indicates to us that further direction change most likely will follow.
Advanced usage
There are several degrees of divergence: 2nd, 3rd, etc. The difference is in the number of tops and bottoms, forming the structure. The second-degree divergence is 2 tops (as in the sample above), the third degree is three tops and so on. Here is a sample of a triple divergence:
While the divergence phenomenon is considered to be a rather strong technical signal, one should remember money management methods and trade risks. The indicator shows the market point, where are the probabilities offset, that is the chance for a favourable outcome in the deal becomes much higher, but it does not guarantee 100% profitable trades.
This educational material is courtesy of IQoption broker. Find out more here.
General Risk Warning: The financial services provided by this website carry a high level of risk and can result in the loss of all your funds. You should never invest money that you cannot afford to lose
