Relative Strength Index (RSI) Formula – How To Trade Overbrought And Oversold

Best Binary Options Brokers 2020:
  • BINARIUM
    BINARIUM

    Top Binary Options Broker 2020!
    Best For Beginners!
    Free Trading Education!
    Free Demo Account!
    Get Your Sign-Up Bonus Now:

  • BINOMO
    BINOMO

    Only For Experienced Traders.

Relative Strength Index (RSI) Trading

The relative strength index (RSI) is an easy-to-use technical indicator that makes trading binary options simple and fast. Newcomers especially can profit from the RSIs clear predictions. If you want to create a binary options strategy that keeps things simple by relying on a simple indicator, the RSI is your best choice. If you want to combine multiple indicators, it is always a good idea to add the RSI to the mix.

In this article you will learn:

  • What Is The Relative Strength Index?
  • How To Interpret The RSI
  • How Can You Trade The Relative Strength Index (RSI) With Binaries?
  • Final Thoughts On Trading RSI

So let’s get started.

What Is The Relative Strength Index?

Technical indicators predict future price movements of an asset by aggregating past movements, calculating a specific value, and displaying the result in a simple-to-understand way. In the case of the RSI, this is a value between 0 and 100 that is drawn into a separate window, usually below your price.

Depending on whether the RSI is closer to the upper or lower end of its range and how its past movements relate to the asset’s price movements, you can predict what will happen next.

All you need for this prediction is a quick look at the value and a short comparison of the RSI line and the price line. You can do all of this in 5 seconds less, which is why the RSI is such an attractive tool for binary options traders.

In the fast-paced world of digital options, it is difficult to find a tool that helps you make a quicker decision about whether you should invest in an asset.

The RSI can be your guide to ultra-quick trading decisions.

How To Interpret The RSI

The RSI provides traders with two indications:

  • Its reading
  • Its past movements in relation to the market’s movements.

Let’s look at both indications individually.

Best Binary Options Brokers 2020:
  • BINARIUM
    BINARIUM

    Top Binary Options Broker 2020!
    Best For Beginners!
    Free Trading Education!
    Free Demo Account!
    Get Your Sign-Up Bonus Now:

  • BINOMO
    BINOMO

    Only For Experienced Traders.

What Does The RSI’s Reading Indicate?

The RSI’s reading indicates the relationship between upwards and downwards movements in the past. Most traders use an RSI based on the last 14 periods. For each of these periods, the RSI calculates the difference between the period’s opening and closing price. It adds up the values of all periods of rising prices and divides the results by the added value

Sounds complicated? Don’t worry. It is rather simple:

  • If the last 14 periods all featured rising prices, the RSI has a value of 100.
  • If the last 14 periods all featured falling prices, the RSI has a value of 0.
  • If the market rose just as much as it fell over the last 14 periods, the RSI has a value of 50.

Learn these three values, and you know what an asset is doing at a glance.

Momentum Strength

But the RSI can do even more for you. It can help you judge the strength of a movement. You already know that values over 50 indicate rising prices and values below 50 indicate falling prices. Now consider the implications of the distance between the RSI’s current value and the 50 line:

  • If the market rose more than it fell over the last 14 periods, the RSI has a value of more than 50. The higher the value, the higher the surplus of rising prices.
  • If the market fell more than it rose over the last 14 periods, the RSI has a value of less than 50. The lower the value, the higher the surplus of falling prices.

Bottom line: the closer the market gets to 100 or 0, the stronger the movement.

  • If the RSI reading increased and this increase accelerated, you know that the market is moving upwards and that the movement is gaining strength.
  • If the RSI reading increased and this increase decelerated, you know that the market is moving upwards and that the movement is getting weaker.

Finally, there are the overbought and oversold lines. These lines are based on a simple logic: a stock’s price direction is solely determined by supply and demand. When there are more buyers than sellers, the prices goes up; when there are more sellers than buyers, the price goes down. But what if everyone has already bought or sold?

Market Forces

Assume that there is a perfect stock. It is so perfect that everyone in the world has invested as much money in it as they can. Now, even if the company is doing well, the only way for the stock is down. There is nobody left to buy the stock. Even if a single person sells it, the price will fall. Because there are so many more people who already have the stock than people who could want it, the only possible outcome is a long downtrend – regardless of how well the company is doing.

The RSI can help you to profit from such situations. Most traders use the values of 70 (overbought) and 30 (oversold), some also use 25 and 75 or 20 and 80.

When the market moves above the upper boundary, they consider the market overbought. Too many traders have bought the asset in the recent past, which means that supply will likely outweigh demand and the price will fall.

When the market moves below the lower boundary, they consider the market oversold. Too many traders have sold the asset in the recent past, which means that demand will likely outweigh supply and the price will rise.

With these indications, the RSI can tell you a lot about what is going on in the market.

What Do The RSI’s Past Movements Indicate?

The second way in which traders use to RSI is to compare it to the current market trend. When an asset is trending, it develops continuously higher highs and lows (in an uptrend) or continuously lower highs and lows (in a downtrend). These zig-zag movements are great trading opportunities because they can continue for a long time, which makes predictions easy.

In a trustworthy trend, the RSI mirrors the market’s movements:

  • In an uptrend: If the market is creating a new high, the RSI should be creating a new high, too.
  • In a downtrend: If the market is creating a new low, the RSI should be creating a new low, too.

If the market creates a new high (in an uptrend) or low (in a downtrend), but the RSI fails to mirror this move, traders speak of a failure swing.

Failure swings are strong signs that a trend is losing momentum and might end soon. Apparently, the market is no longer moving as quickly as before; the momentum that pushed the asset in a strong direction is gone. Now, the trend will likely end, and the market will turn around.

These are the two most popular ways of interpreting the RSI. Now let’s look at how you can turn them into profitable binary options trades.

How To Trade The Relative Strength Index (RSI)

Binary options allow you to trade the RSI with several strategies. They differ in risk, time requirement, and the number of created signals. Let’s look at each strategy individually.

Trading Oversold And Overbought Indicators

When the market reaches the oversold or overbought regions of the RSI, something is going on. Unfortunately, it can be difficult to pinpoint what exactly this something is.

When the market reaches the overbought/oversold area, the RSI predicts that it will turn around soon. During solid trends, however, the market often stays in the overbought/oversold area for quite some time. You should be careful before you blindly invest in a turnaround once the market reaches an extreme area.

Instead, try to understand what is going on instead and act accordingly. You have these options:

  1. Invest right away: Long lasting trends are especially common on long time frames – when you look at charts that display the price movements of a full year or more, for example. On the short time frames that you trade with binary options, market movements are erratic and long-lasting trends rare. If you think that your asset is unlikely to develop a long trend, you can throw caution to the wind and invest right away. You should use a high/low option and choose a little bit longer expiry. Give the market enough time to turn around. Once it does, you will win your option, so it’s better to invest a little longer than shorter.
  2. Wait for a second signal: Some traders want the market to confirm its first signal. Once the RSI enters the overbought/oversold are, they wait until it leaves the area again. Now, the trend is over, and they can invest. In this case, the market has already moved in its new direction, which is why you should keep your expiry shorter.
    Regardless of when you invest, this type of strategy will create many signals for you. It has a high potential – many trades can mean high earnings – but it also bears more risk. Start slow and increase the pace as you feel more and more comfortable.

Trading The RSI’s Direction And Momentum

The RSI’s direction tells you whether the market is rising or falling, the RSI’s speed tells you whether the movement is gaining or losing strength. This is all you need to invest.

  • When the RSI is moving upwards and accelerating, you know that there is a strong upwards movement and a good chance of winning a high option.
  • When the RSI is moving downwards and accelerating, you know that there is a strong downwards movement and a good chance of winning a low option.

Risks

The risk of this strategy depends on how you interpret the RSI’s direction. If the RSI has moved up for six periods and down for one, it is probably not yet moving downwards. Wait until there are enough periods to confirm the direction.

Additionally, some traders like only to trade the RSI’s upwards movements when they start below the 50 mark and downwards movements when they start above the 50 mark. Because the movement starts far away from the extreme value for its direction, this safety measure guarantees that there is enough room for a long movement to develop, which increases the chances of winning a binary option.

In any case, you should use a short to medium expiry. Since the market is currently moving in the right direction, there is no sense in waiting for things to change.

Trading Failure Swings

Probably the safest way of trading the RSI is trading failure swings. Failure swings only happen when something is very wrong with a trend, and they are a sure indication of a turnaround.

When you find a failure swing, invest in the opposite direction of the preceding trend:

  • During an uptrend, invest in a low option.
  • During a downtrend, invest in a high option.

Choose a long expiry. The market can go through a short sideways movement after a failure swing, and you want your expiry to be long enough to last until the market is going down. Once it is going down, it is likely to fall for some time, so it is better to err on the side of caution and choose a long expiry.

Final Thoughts On Trading RSI

The RSI works best when the market is in a trend. Some traders also use the RSI during sideways movements, but if you are new to the RSI, we recommend starting with trends.

If you want, you can combine the RSI with other indicators. Obviously, trend analysis would be a logic choice, but you can also mix in candlestick formations and moving averages.

The Relative Strength Index is easy to interpret, which makes it great for beginners. If you are just starting out and want to use the RSI, please avoid the mistake of only learning the RSI. There is so much going on in the market, and to truly trade well, you need to understand it.

Conclusion

The RSI is an easy-to-understand technical indicator that is especially great for newcomers.

You can trade the RSI by monitoring its overbought/oversold areas, its direction and momentum, and its movement in comparison to market movements.

We recommend trading the Relative Strength Index with high/low option and an expiry adjusted to your trading strategy.

Overbought or Oversold? Use the Relative Strength Index to Find Out

The Relative Strength Index (RSI) describes a momentum indicator that measures the magnitude of recent price changes in order to evaluate overbought or oversold conditions in the price of a stock or other asset. Originally developed by noted American technical analyst J. Welles Wilder Jr., who introduced the concept in his seminal 1978 book, “New Concepts in Technical Trading Systems,”   the RSI is displayed as an oscillator, which is a line graph that moves between two extremes. Its reading can range from 0 to 100.

The primary trend of the stock or asset is an important tool used to ensure that the indicator’s readings are properly understood. Well-known market technician Constance Brown has widely promoted the idea that an oversold reading on the RSI that occurs in an uptrend is likely much higher than 30%, and an overbought reading on the RSI that occurs during a downtrend is much lower than 70%. 

Traditional interpretation and usage of the RSI dictates that values of 70 or above suggest that a security is becoming overbought or overvalued and may be primed for a trend reversal or corrective price pullback. An RSI reading of 30 or below indicates an oversold or undervalued condition.

Key Takeaways

  • In finance, the Relative Strength Index (RSI) is a type of momentum indicator that looks at the pace of recent price changes so as to determine whether a stock is ripe for a rally or a selloff.
  • The RSI is used by market statisticians and traders, in addition to other technical indicators as a means of identifying opportunities to enter or exit a position.
  • Generally, when the RSI surpasses the horizontal 30 reference level, it is a bullish sign and when it slides below the horizontal 70 reference level, it is a bearish sign.

Overbought and Oversold Levels

In terms of market analysis and trading signals, when the RSI moves above the horizontal 30 reference level, it is viewed as a bullish indicator.

Conversely, an RSI that dips below the horizontal 70 reference level is viewed as a bearish indicator. Since some assets are more volatile and move quicker than others, the values of 80 and 20 are also frequently-used overbought and oversold levels.

Relative Strength Index – RSI

What Is Relative Strength Index – RSI?

The relative strength index (RSI) is a momentum indicator that measures the magnitude of recent price changes to evaluate overbought or oversold conditions in the price of a stock or other asset. The RSI is displayed as an oscillator (a line graph that moves between two extremes) and can have a reading from 0 to 100. The indicator was originally developed by J. Welles Wilder Jr. and introduced in his seminal 1978 book, New Concepts in Technical Trading Systems.

Traditional interpretation and usage of the RSI are that values of 70 or above indicate that a security is becoming overbought or overvalued and may be primed for a trend reversal or corrective pullback in price. An RSI reading of 30 or below indicates an oversold or undervalued condition.

Key Takeaways

  • The RSI is a popular momentum oscillator developed in 1978.
  • The RSI compares bullish and bearish price momentum plotted against the graph of an asset’s price.
  • Signals are considered overbought when the indicator is above 70% and oversold when the indicator is below 30%.

The Formula for RSI

The relative strength index (RSI) is computed with a two-part calculation that starts with the following formula:

The average gain or loss used in the calculation is the average percentage gain or losses during a look-back period. The formula uses positive values for the average losses.

The standard is to use 14 periods to calculate the initial RSI value. For example, imagine the market closed higher seven out of the past 14 days with an average gain of 1%. The remaining seven days all closed lower with an average loss of -0.8%. The calculation for the first part of the RSI would look like the following expanded calculation:

Once there are 14 periods of data available, the second part of the RSI formula can be calculated. The second step of the calculation smooths the results.

Calculation of the RSI

Relative Strength Index (RSI)

Using the formulas above, RSI can be calculated, where the RSI line can then be plotted alongside an asset’s price chart.

The RSI will rise as the number and size of positive closes increase, and it will fall as the number and size of losses increase. The second part of the calculation smooths the result, so the RSI will only near 100 or 0 in a strongly trending market.

As you can see in the above chart, the RSI indicator can remain in “overbought” territory for extended periods while stock is in an uptrend. The indicator can stay in “oversold” territory for a long time while stock is in a downtrend. This can be confusing for new analysts, but learning to use the indicator within the context of the prevailing trend will clarify these issues.

What Does RSI Tell You?

The primary trend of the stock or asset is an important tool in making sure the indicator’s readings are properly understood. For example, well-known market technician Constance Brown, CMT, has promoted the idea that an oversold reading on the RSI in an uptrend is likely much higher than 30%, and an overbought reading on the RSI during a downtrend is much lower than the 70% level.

As you can see in the following chart, during a downtrend, the RSI would peak near the 50% level rather than 70%, which could be used by investors to more reliably signal bearish conditions. Many investors will apply a horizontal trendline that is between 30% or 70% levels when a strong trend is in place to better identify extremes. Modifying overbought or oversold levels when the price of a stock or asset is in a long-term, horizontal channel is usually unnecessary.

A related concept to using overbought or oversold levels appropriate to the trend is to focus on trading signals and techniques that conform to the trend. In other words, using bullish signals when the price is in a bullish trend and bearish signals when a stock is in a bearish trend will help to avoid the many false alarms the RSI can generate.

Divergences Example of RSI Use

A bullish divergence occurs when the RSI creates an oversold reading followed by a higher low that matches correspondingly lower lows in the price. This indicates rising bullish momentum, and a break above oversold territory could be used to trigger a new long position.

A bearish divergence occurs when the RSI creates an overbought reading followed by a lower high that matches corresponding higher highs on the price.

As you can see in the following chart, a bullish divergence was identified when the RSI formed higher lows as the price formed lower lows. This was a valid signal, but divergences can be rare when a stock is in a stable long-term trend. Using flexible oversold or overbought readings will help identify more valid signals than would otherwise be apparent.

RSI Swing Rejections Example

Another trading technique examines the RSI’s behavior when it is re-emerging from overbought or oversold territory. This signal is called a bullish “swing rejection” and has four parts:

  1. RSI falls into oversold territory.
  2. RSI crosses back above 30%.
  3. RSI forms another dip without crossing back into oversold territory.
  4. RSI then breaks its most recent high.

As you can see in the following chart, the RSI indicator was oversold, broke up through 30% and formed the rejection low that triggered the signal when it bounced higher. Using the RSI in this way is very similar to drawing trendlines on a price chart.

Like divergences, there is a bearish version of the swing rejection signal that looks like a mirror image of the bullish version. A bearish swing rejection also has four parts:

  1. RSI rises into overbought territory.
  2. RSI crosses back below 70%.
  3. RSI forms another high without crossing back into overbought territory.
  4. RSI then breaks its most recent low.

The following chart illustrates the bearish swing rejection signal. As with most trading techniques, this signal will be most reliable when it conforms to the prevailing long-term trend. Bearish signals in negative trends are less likely to generate a false alarm.

RSI vs. MACD

The Moving Average Convergence Divergence (MACD) is another trend-following momentum indicator that shows the relationship between two moving averages of a security’s price. The MACD is calculated by subtracting the 26-period Exponential Moving Average (EMA) from the 12-period EMA. The result of that calculation is the MACD line. A nine-day EMA of the MACD called the “signal line,” is then plotted on top of the MACD line, which can function as a trigger for buy and sell signals. Traders may buy the security when the MACD crosses above its signal line and sell, or short, the security when the MACD crosses below the signal line.

The RSI aims to indicate whether a market is considered to be overbought or oversold in relation to recent price levels. The RSI calculates average price gains and losses over a given period of time; the default time period is 14 periods with values bounded from 0 to 100.

The MACD measures the relationship between two EMAs, while the RSI measures price change in relation to recent price highs and lows. These two indicators are often used together to provide analysts a more complete technical picture of a market.

These indicators both measure momentum in a market, but because they measure different factors, they sometimes give contrary indications. For example, the RSI may show a reading above 70 for a sustained period of time, indicating a market is overextended to the buy side in relation to recent prices, while the MACD indicates the market is still increasing in buying momentum. Either indicator may signal an upcoming trend change by showing divergence from price (price continues higher while the indicator turns lower, or vice versa).

Limitations Of The RSI

The RSI compares bullish and bearish price momentum and displays the results in an oscillator that can be placed alongside a price chart. Like most technical indicators, its signals are most reliable when they conform to the long-term trend. True reversal signals are rare and can be difficult to separate from false alarms. A false positive, for example, would be a bullish crossover followed by a sudden decline in a stock. A false negative would be a situation where there is a bearish crossover, yet the stock accelerated suddenly upwards.

Since the indicator displays momentum, as long as an asset’s price momentum remains strong (either up or down) the indicator can stay in overbought or oversold territory for long periods of time. Therefore, the RSI is most trustworthy in an oscillating market when the price is alternating between bullish and bearish periods.

Best Binary Options Brokers 2020:
  • BINARIUM
    BINARIUM

    Top Binary Options Broker 2020!
    Best For Beginners!
    Free Trading Education!
    Free Demo Account!
    Get Your Sign-Up Bonus Now:

  • BINOMO
    BINOMO

    Only For Experienced Traders.

Like this post? Please share to your friends:
Binary Options Theory and Practice
Leave a Reply

;-) :| :x :twisted: :smile: :shock: :sad: :roll: :razz: :oops: :o :mrgreen: :lol: :idea: :grin: :evil: :cry: :cool: :arrow: :???: :?: :!: