Using The Relative Strength Index Technical Indicator

Many traders use the Relative Strength Index indicator, or RSI for short, but it can be a very dangerous indicator if used in isolation and indeed a lot of traders don't use this indicator correctly.

I remember not long after I first started trading I discovered the RSI indicator. I was immediately impressed. I had read that an RSI reading above 80 indicated an overbought position and a reading below 20 indicated an oversold position. After doing a lot of back-testing I realised how good this indicator was at predicting reversals.

However after doing a lot of live trading on both shares and forex, I quickly realised that trading wasn't this easy. Many times the RSI will indicate an oversold position, only for the price to reverse slightly before falling even further and creating another oversold position.

In short, the RSI indicator should not be used in isolation. It should be used in conjunction with several indicators like stochastics, MACD and moving averages, for example, in order to build up a bigger picture of what the price is likely to do in the future.

In addition there is arguably a better way you can use the RSI indicator to enter positions and that's by using the 50 level rather than the extreme 20 and 80 levels.

Very often the price will be overbought, for example at say 70 or 80 and will reverse to about 55 or 60, taking the price down slightly, before continuing it's uptrend. In other words it was a false reversal. However when the RSI moves through 50, this is a strong indication that a true change of trend is taking place. So the RSI crossing upwards through 50 indicates a bullish trend and vice versa.

You do miss some of the initial reversal trading this way but at least you can be more confident of your position when the RSI moves through 50.

For an even more productive method of trading you can combine the RSI with other indicators. For example when short-term trading one of my trading methods is to go long when the RSI crosses upwards through 50 in conjunction with the stochastic crossing through 50 and the MACD and EMA's crossing at the same time, for additional confirmation.

This is a much more profitable and reliable trading method, in my opinion, than just using the RSI on it's own to identify overbought and oversold positions.

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