The RSI help traders evaluate the strength of the current market
MEASURING MARKET TREND STRENGTH
The Relative Strength Index (RSI) is an oscillator type indicator that moves up and down in response to a change in market rates introduced by Wells Wilder in 1978.
A reading of 30 or under is considered oversold and identifies a potential rate increase.
A reading of 70 or higher is considered overbought and identifies a potential rate decrease.
A movement from below the centerline to above is seen as a rising trend.
A crossover from above the centerline to below, indicates a falling trend.
Today's trading platforms are capable of performing the RSI calculation automatically, so it is not necessary for you to do this manually. However, it is helpful for you to understand how the RSI is determined starting with the actual RSI formula:
RSI = 100 - [100 / (1 + RS)] — Where: RS (Relative Strength) = average gain / average loss
This example uses 14 as the number of reporting periods to include when calculating the average gains and average losses. You can choose to change this value on the OANDA platform, but Wilder felt that 14 periods offered the best results.
The first components to be calculated are the total average gains and the total average losses. This information is necessary to arrive at the relative strength (RS) value for the currency pair.
Average gains are calculated by totaling all the gains for the past fourteen reporting periods and dividing by 14. Average losses are calculated in the same manner with the total of all losses for the previous 14 reporting periods summed and divided by 14.
The Relative Strength is then converted to an index value and plotted on Wilder's scale ranging from 1 to 100.
READING RSI SIGNALS
The RSI is straight-forward to interpret and produces very clear trade signals. The RSI scale has two defined regions — one starts at 0 and goes to 30, and the second covers the scale from 70 to 100.
According to Wilder, an RSI value falling within the 0 to 30 region is considered oversold. Some traders assume that an oversold currency pair is an indication that the falling market trend is likely to reverse, thus an opportunity to buy (i.e. a bullish signal).
On the other hand, an RSI value falling into the 70 - 100 region of the scale, is regarded as being overbought. This signal suggests that the resistance level for the currency pair is near or has been reached and the rate is likely to fall. Some traders would interpret this as a sell opportunity (i.e. a bearish signal).
In addition to the overbought and oversold indicators described above, technical traders using the Relative Strength Index also look for what is known as a centerline crossover.
↗ A rising centerline crossover occurs when the RSI value crosses over the 50 line on the scale, moving towards the 70 line. This indicates the market trend is increasing in strength, and is seen as a bullish signal until the RSI approaches the 70 line (i.e. the overbought region).
↘ A falling centerline crossover is an indication of weakening strength and so long as the value does not drop below 30 into the oversold region of the scale, is considered a bearish signal. This crossover occurs when the RSI value crosses under the 50 line towards the 30 line.
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Fundamental traders watch interest rates, employment reports, and other economic indicators trying to forecast market trends.
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