RSI Divergence can be a great way to spot potential trading opportunties.

But it can also be easy to miss these opportunties because you're working or just busy with everyday life.

It can also be hard to spot these opportunties on the chart, if you're distracted.

So I'll show you how TradingView makes it super easy to spot these opportunties with their free built-in indicator.

TradingView is a fantastic trading and charting platform and you can find out more about why I switched to TradingView here.

What is RSI Divergence?

Divergence is a term that refers to when the Relative Strength Index (RSI) indicator has a reading that's different (divergent) from price action.

Here's an example where the second and third price highs are higher than the first high, but the highs on RSI are lower.

This is a bearish signal, as shown on the bottom of the chart.

As you can see, this trade ended up working out well.

Sometimes it can be difficult to spot these divergences, even if you know what to look for. That's where an indicator can help a lot.

Before I get into the indicator, to learn all of the details about RSI Divergence and see more examples, read this guide.

How to Add the Indicator to Your Chart

Adding the indicator to your chart is easy.

Simply click on the Indicators button at the top of the screen in TradingView. Then in the search box, type in: “rsi divergence“.

This will bring up a list of indicators and trading strategies that help with RSI Divergence.

Select the first indicator on the list.

This is the official indicator developed by TradingView.

Once you click on the link, the indicator will be added to your chart.

How to Set Up the Indicator

The indicator has simple settings that you can use to fine tune your signals.

I like when there are only a few settings.

Many times, developers nerd out and create dozens of settings that aren't necessary.

To change the settings, right-click on the indicator and select Settings.

The next window will allow you to change the settings. The first 2 settings are the standard RSI settings.

Change those settings according what you use.

The settings that may be a little confusing are explained here:

• Pivot lookback right: The number of candles to look to the right for a pivot (peak or valley), from a pivot, to be used as a point for divergence. I guess that would technically be a look forward, not a back.
• Pivot lookback left: The number of candles to look to the left for a pivot (peak or valley), from a pivot, to be used as a point for divergence
• Max of lookback range: The maximum number of candles to include in a divergence
• Min of lookback range: The minimum number of candles to include in a divergence

From there, you can select which divergences you want to see on your chart.

Click the OK button when you're done.

Add a RSI Divergence Alert to Get Notifications on Your Phone

Another fantastic thing about TradingView is that you can setup alerts on most indicators.

That means you can get notifications on the mobile app, or via email.

To setup alerts on the indicator, right-click anywhere on the indicator. Then select Add alert…

At the top of the alert window, select the type of divergence you want to get alerts for.

In this example, I'm setting up alerts for Regular Bearish Divergence.

Create a separate alert for each type of divergence you want to be notified about.

Other RSI Divergence Tools in TradingView

The great thing about TradingView is that you can use free indicators and trading strategies that other people on the platform have developed.

This can help you improve your strategy or test out new ideas.

To see all of the available RSI Divergence indicators and strategies, go through the same steps above to add the RSI Divergence indicator to your chart.

But instead of adding the default indicator under Technicals, look below that in the Community Scripts section.

This is where you can try out other indicators and trading strategies.

In many cases, the user-created scripts aren't great. Just like in the MetaTrader Code Base, most are half-baked.

But once in awhile, you'll find an awesome one that's super useful.

You can also quickly backtest the trading strategies in the Strategy Tester, which gives you instant feedback on how good the strategy is.

So even if you don't see something useful right now, keep checking back because the community is adding new scripts all the time.

Does RSI Divergence Actually Work?

There are different ways to trade RSI Divergence.

You can learn many RSI Divergence trading methods on blogs or on YouTube.

I've posted some of my backtesting results here. My test was profitable, but it needs some optimization.

It's a good starting point though, and you can test out some optimizations for yourself.

The most important thing to understand if you want to be successful with RSI Divergence, is that you have to develop a trading strategy that works for YOU.

That means that you have to backtest your RSI trading strategy. You can get started with this tutorial.

If you want to learn the complete process, then take my StrategyEVO Backtesting Course.

Conclusion

So if you like TradingView for charting like I do, then this indicator makes it super easy to see divergence and get an alert when it happens.

The best part is that this handy indicator comes with TradingView and you don't have to pay anything extra.

To get a free trial of TradingView, go here.

The post How to Use the RSI Divergence Indicator in TradingView appeared first on Trading Heroes.

Traders have come up with creative and profitable ways to use this indicator and it's available on every trading platform.

However, what's not available on every platform is the ability to get alerts when RSI hits signal levels.

Luckily, there's a great solution.

TradingView provides RSI alerts standard on their trading/charting platform.

In this tutorial, you'll learn the benefits of using these alerts, how to set them up and a great RSI alerts alternative if you prefer to use another platform. 

Benefits of Using TradingView for RSI Alerts

The biggest benefit to using TradingView is that your alerts are hosted on their server, so you don't have to keep your computer on all day.

Even if you did use your own computer, it could go to sleep, your internet connection might go down, and there could be a power outage.

With TradingView, you don't have to worry about any of those things.

When your money is on the line, you want to be sure that you're aware of every single trading opportunity.

How to Setup TradingView to Send RSI Alerts

Start by opening a chart and clicking on the Indicators button.

Search for the Relative Strength Index indicator and select it.

You will now see the indicator on your chart.

Then right-click on the RSI line and click on the Add alert on RSI menu option.

You'll then see the alert settings window.

Set the alert as follows.

If you use 2 alert lines, like the 70/30 or the 80/20, then you'll have to setup 2 alerts.

Here's how to setup an alert on the 30 line.

Check the boxes next to the alerts that you want to receive.

That's it!

You will now get RSI alerts via the methods that you selected in the settings.

It's best to download the mobile app to your phone or tablet, and use the Notify on app option.

That way, you can get alerts anywhere.

TradingView RSI Alerts Alternative

TradingView is a paid platform and may not be within the budget of all traders.

So if you don't want to pay for TradingView, then luckily there are some alternatives.

My favorite alternative is MetaTrader.

It's free to download and it's a solid piece of software.

The downside is that you cannot get RSI alerts on the stock version of MetaTrader.

However, we have created custom indicators that will send RSI alerts to your phone, email or your computer. 

You only have to pay a small price for them once, unlike the monthly recurring charge of TradingView. The only downside is that you have to leave your computer on all the time to get alerts.

If that works for you, then see our MetaTrader RSI alert indicators here.

Trading Strategies that Use RSI

There are several strategies that use the RSI indicator as it's primary indicator.

You may have your favorite already, but here are some ideas that you may want to explore in backtesting.

• RSI divergence
• 50 line crossover
• RSI overbought/oversold 
• Connors RSI 2

Final Thoughts

With our busy lives, it can be easy to miss trading signals on the RSI.

Setting up an alert in TradingView will ensure that you don't miss any of them.

If you want to learn the specifics of RSI, read this post.

The post How to Setup RSI Alerts on TradingView appeared first on Trading Heroes.

Using divergence is a popular way to identify potential trading opportunities. But how does it work and when does it stop working?

RSI Divergence occurs when the Relative Strength Index indicator starts reversing before price does.

A bearish divergence consists of an overbought RSI reading, followed by lower high on RSI. At the same time, price must make a higher high on the second peak, where the RSI is lower. In a bullish divergence situation, there must be an oversold condition on the RSI, followed by a higher low on the RSI graph. Simultaneously, price must form a lower low on the second peak.

Now let's take a closer look at some examples of RSI divergence and how you can use it to identify potentially profitable trading opportunties.

What is RSI Divergence?

Another way to look at RSI divergence is that RSI can show a change in price momentum, before you see a change in price action. You can think of it as an early warning signal.

In other words, it helps traders spot potential price reversals.

RSI Divergence Examples

It can be tough to visualize divergence from words alone, so now let's take a look at few charts, so you can see divergence in action.

I'll give you examples of both bearish and bullish divergence.

Bearish Divergence

Here's an example of bearish divergence. Price finds 2 new highs, but on the RSI, there are 2 new lows.

This can give you a hint that upward momentum is slowing down and a downward move could be coming soon.

One thing to notice about this example is that there are 2 divergence signals here. You might have traded the first divergence and possibly been stopped out.

If you didn't take the second divergence, then you would have been stuck with a loss.

So it can help to re-enter a trade if your basic analysis of the trade stays the same.

Bullish Divergence

As you would expect, bullish divergence is just the opposite of bearish divergence.

First look for an oversold signal on the RSI indicator.

Next, look for a lower low in price action and a higher low in RSI.

The higher low in the RSI does not have to be in the oversold area for the signal to be valid.

Here's an example of bullish divergence on the AUDCHF.

How Do You Confirm RSI Divergence?

The first thing to understand is that you cannot “confirm” any trading signal, in a way that would guarantee a profitable outcome.

You probably understand that, but some new traders think that there's a way to always be sure of a winning trade.

That's simply not possible.

Trading is about wins and losses.

However, you should do everything you can to verify that you have a legitimate divergence trading signal…before taking a trade. 

Luckily, there are only a few variables that go into a valid divergence signal.

The first thing to look for in RSI divergence is a situation where RSI is in an overbought or oversold condition.

This shows that there is a relatively extreme move and price is likely to bounce back from that level.

Then look for a situation after that where:

• Oversold: Price forms a lower low, but RSI forms a higher low
• Overbought: Price forms a higher high, but RSI forms a lower high

Also remember that the candle has to close for it to be a true RSI divergence signal.

Do not take trades before the candle closes and you get a verified divergence.

In order to take advantage of as many divergence signals as possible, it helps to have a RSI divergence alert indicator.

It's installed on a desktop or laptop and can send an alert via: email, text message (where available) and/or push notification via the mobile app.

What are the Settings for RSI Divergence?

Just like with any other indicator based trading strategy, the specific settings for the RSI indicator will vary between traders.

However, the best place to start is with the default RSI settings:

• 14 period
• 30/70 signal levels

Where Can I Get an RSI Divergence Indicator?

It can be a little tough to get an indicator that shows divergence. 

This is because the calculation is tricky and it can be hard to get it right. 

But TradingView does have a RSI divergence indicator that works pretty well. 

That's an easy way to see divergences. 

Divergence Trading Strategy Optimization

Now that you understand what RSI divergence is, let's take a look at a few ways to optimize a divergence trading strategy.

These methods can help you increase your win rate or average profit per trade.

Use Support and Resistance

You can increase your odds of winning by looking for support and resistance levels that coincide with RSI divergence.

The key is to look for a very clear support/resistance level. 

This is what a good signal looks like.

Notice how far back you would have had to look back to identify the support level.

Trailing Exit

Another way to maximize your profits on a RSI Divergence trade is to trail your stop loss.

Like with any other trading method, changing your exit method does have trade-offs. When you start using a trailing exit, your win rate will probably go down.

On the bright side however, trailing your stop loss can increase your overall profits and you can potentially automate your exits.

As the saying goes:

Cut your profits short and let your profits run.

How do you trail your stop loss?

There are many ways to do this, but I'll give you 2 examples.

One popular method is to use the Parabolic SAR indicator. It prints dots above or below every candle.

In this example of a long trade, you could trail your stop loss at one or two PSAR levels back from the current candle.

If you don't like the rigidity of the PSAR indicator, another way to trail your stop is to move it to the next support or resistance level.

For example, here's a chart where there was a RSI divergence and the market started to trend.

By trailing your stop loss at each blue line, you would have been able to lock in profits as price moved in your favor. This move would have made much more profit, compared to simply targeting 1R or the next support level.

Fixed Profit Targets

If you don't like the uncertainty of trailing profit targets, or targeting support/resistance levels, then fixed profit targets could be right for you.

A good place to start with fixed targets is to simply set take profit orders at risk multiple levels.

For example you could start with 1X risk, or 1R, as a profit target.

So if your stop loss was at 100 pips, you could set your take profit at 100 pips.

If you want to automate your “R” trailing stop, you can get our Risk Multiple Trailing Stop EA for MetaTrader 4.

It will manage your trailing stop automatically, according to the amount of risk you took on the trade.

This method is especially helpful if you find that you are frequently right about a price move, but then price retraces against you and you either get stopped out, or price hits breakeven.

Different charting platforms have different ways that you can mark off multiples of risk.

My favorite way is to use TradingView's Risk/Reward tool.

Here's how the tool works.

Another way to do it is to use the Fibonacci tool on any charting platform.

The tool can be repurposed to show to the multiples of risk on any trade you're looking for.

Since you can add multiple levels to the Fibonacci tool, it can show you 1R, 2R…10R, etc.

This video will show you how to do it in MetaTrader.

When Does RSI Divergence Fail?

Just like any other trading methodology, divergence will not work 100% of the time. 

The most common instance when divergence fails, is in strongly trending markets. If you take too many divergence trades in a strong trend, you will lose a lot of money.

So be sure to have a solid money management plan in place. 

Here's an example:

Learn to identify when you're in a trend and have something like a 2-strikes rule, to cut your losses short.

Your win rate and percent return will also be determined by your exit strategy, the quality of your execution, and your ability to objectively analyze your results.

The most common reasons for the failure of any trading system are:

• Not enough testing
• Giving up too early
• Not journaling your trades properly
• The strategy doesn't have an edge
• Unrealistic expectations
• Not knowing your expected statistics
• Missing good trading opportunities

Those are issues primarily related to your trading psychology and trading process. Therefore, if you have a trading strategy that has an edge and you're on a losing streak, then you need to look at your process and psychology.

Don't switch systems just because you have a losing streak. It might not be an issue with your strategy.

Take an objective look at all elements of your trading. 

Conclusion

So that's how RSI divergence works.

You may also be wondering how hidden RSI divergence works.

That's a totally different animal, so I'll cover that in a future tutorial.

But for now, if RSI divergence appeals to you, then work on solidifying a real trading strategy.

Remember that although divergence may look good in a few well-chosen examples, you need to have a complete, well-tested trading strategy in order to have long-term success with RSI divergence.

This starts with creating a trading plan and backtesting your plan.

Then if your strategy passes those tests, you can move into beta testing…and if that works out, then to live trading.

Take the time to go through this process.

If you rush into live trading, you'll just end up on the Trading Silodrome.

In future updates, I'll show you more examples of RSI Divergence testing results and how you can become a better RSI trader.

Until then, be sure to look at my RSI divergence testing results on the daily chart of 27 currency pairs.

To get alerts when RSI divergence happens, use this indicator.

The post RSI Divergence Explained appeared first on Trading Heroes.

In this post, I'll show you my actual results from backtesting the RSI Divergence strategy on 27 currency pairs. The test had an overall +235.39% cumulative return, showing that this could be a viable RSI strategy for swing trading.  

But remember that good backtesting results do not guarantee success in live trading. Always test strategies for yourself, never trust anyone that says a strategy works (including me). You may have a different way of looking at the market, which will cause you to trade it in a different way.

Backtesting also helps to:

• Show you if a strategy has a historical edge and works for you
• Give you a reference point to compare your live trades
• Build your confidence in trading a strategy
• Give you practice with a trading strategy (even when the markets are closed)

Just to be clear, this was a manual backtest.

I might try to automate this strategy (or do Incremental Automation) in the future, but I was looking for a manual trading strategy, so that's how I tested it.

Alright, now let's get into the details…

The RSI Divergence Swing Trading Strategy

This strategy uses RSI Divergence to identify potential trades. To learn the basics of divergence, read RSI Divergence explained.

If you want the complete trading strategy plan that I tested, you can get it in this blog post. For a detailed description of how the RSI indicator works, read this blog post.

There are some trade entry filters that might make my entries different from how other traders trade it, so be sure to reference the strategy blog post if you have any questions.

I only tested this strategy on the daily chart.

Testing Tools

For this round of testing, I only used 2 tools:

• Forex Tester
• Numbers for Mac

Forex Tester speeds up the process by automatically recording your trades, calculating stats and gives you an easy way to download historical data.

Trading Heroes readers get a discount on Forex Tester. Click here to get your discount coupon.

You can also use other platforms like TradingView or MT5, but the process will be slower because you have to update a second spreadsheet to record your trades.

I only used Numbers to record the results of testing, so I could get totals and averages.

Historical Time Period

I tested each pair with as much historical data as I could get my hands on.

Most of the major currency pairs were tested from 2003. The crosses and more exotic pairs were tested from 2006, and a couple started as late as 2012.

That's the data that Forex Tester had available, so that's what I used.

Testing Time

Since this test was done on the daily chart, each pair could be tested in about 90 minutes. So the total test took about 40 hours. 

When testing the daily timeframe and higher, it's possible to test all of the data in a reasonable amount of time, so I do a complete test.

If I'm testing a lower timeframe, I usually “spot test” certain date ranges to get a good feel for how well the strategy works, without wasting time.

The most important thing to note here is that most trading strategies out there are easy to learn.

However, most new traders don't understand the additional work that goes into mastering a trading strategy.

Testing and practicing a strategy takes time. 

Anyone who tells you that you can learn a strategy today and be successful tomorrow is straight-up lying to you. 

So if you are serious about becoming a successful trader, you need to put in the time to test and practice.

Overall Stats

Before we start digging into the results from each currency pair, here are the overall stats:

• Average win rate per pair: 78.74%
• Average return per pair: 8.71%
• Average number of trades per pair: 14
• Total number of trades: 373
• Total return: 235.29%

Since this is a swing trading strategy, a lower number of trades per year is expected.

The yearly return may also seem a little low to some traders.

Before you write off this strategy however, consider this:

• You can always add more strategies later
• This might also work on lower timeframes
• You might be able to add more currency pairs
• You might be able to increase the return on each trade

But these initial results are solid and worth moving forward with. Now let's get into the specific results by currency pair.

Backtesting Results

Win Rate

First let's look at the win rate. The win rate for this strategy was pretty high, averaging about 79% per pair.

So this is potentially a good strategy for traders who like to win a lot.

In the future, I could test going for bigger wins per trade, but at a lower win rate.

However, for now, I like these results, so I'm going to move forward.

Total Return

Now let's look at the total return for each pair.

Again, these returns look low because if you divide each of them by the number of years tested, you get a really small number. However, if you add all of the pairs together, the average is about 13% per year.

Not too shabby for one simple swing trading strategy. Add a couple more strategies with a similar return and you can potentially beat many fund managers.

Of course, you could filter out some of the lower performing pairs, to potentially boost the performance of the strategy.

Number of Trades

Finally, let's take a look at the number of trades that were executed for each currency pair.

Some people may say that this isn't a valid test because there weren't enough trades per test to achieve a high enough level of confidence. There is some validity to that argument…if I only tested 2 or 3 pairs.

However, when you test the same strategy across 27 pairs, you can get a big enough data set to make some statistically valid conclusions. Since there were 373 trades in this round of testing, that's more than enough trades to warrant moving on to the next step of forward testing (or beta testing).

How to Get RSI Alerts

Luckily it's easy to setup alerts, when trading RSI. This means that you don't have to sit in front of your computer all day, in order to spot RSI trades.

There are 3 simple steps to using an alerts indicator for RSI divergence trading:

1. Install the indicator and set it to your favorite overbought/oversold settings.
2. When the indicator sends you an alert, but that currency pair on your watchlist.
3. Check your watchlist pairs at the close of every candle, if possible. When there is divergence, take a trade.

You can download easy-to-use RSI indicators here.

Final Thoughts on this RSI Strategy for Swing Trading

Since my testing shows that RSI Divergence is potentially a good swing trading strategy, the next step will be to put these into forward testing to see how well this works.

If you want to discuss RSI Divergence every week, join the private group. It's free and can help you find new setups and learn more about this strategy.

Remember not to trade this live, just because backtesting says that this is a good strategy. Backtesting does have its limitations, which I talk about in detail here.

Always do the forward testing step before going live.

The post RSI Strategy for Swing Trading: 27 Pairs on Daily Chart appeared first on Trading Heroes.

Alright, now it's time to see some real results!

Forget the “theories” that you see on other sites. Doing a complete test is the first step to finding out if a strategy actually has an edge.

In the first part of this series, I explained how the RSI indicator works.

Part 2 gave you 3 commonly taught ways to trade the RSI, with complete trading plans. These are methods that can be found on many free websites.

…now it's time to see what happens when you actually test these ideas.

Do these strategies really have an edge, or are they just trading myths?

Let's find out…

Before we get started, remember the Trading Heroes Keys to Backtesting Success:

1. Never trust what you read on the internet about trading strategies. What works for another trader may not work for YOU. So always test strategies for yourself and get hard data.
2. Always test your trading strategies before risking real money. 
3. Past performance does not guarantee future results. But successful trading is based on recognizing repeating patterns, so testing is essential to success. 
4. If your return with one strategy does not meet your goals, remember that you can add: markets, timeframes, pyramiding and/or more strategies. Don't give up on a consistent strategy just because the return is low. 
5. One little tweak in a trading plan can change it from unprofitable to profitable. So test different ideas. 
6. Trading strategies are easy to learn, but hard to master. You need to put in the work: testing, screen time, journaling and reviewing. 
7. Consistently profitable trading is an extremely valuable skill. If you can master trading, there's always the potential to trade other people's money (OPM). Don't give up just because you think that you don't have enough money. 
8. Your live trading results may vary from your testing results. Part of the learning process is to figure out why. 
9. You are 100% responsible for your trading results. These testing results do not guarantee success. 

If you have never backtested, read this blog post.

I tested these strategies with Forex Tester.

But you can also use other programs like MT4, NakedMarkets or TradingView.

RSICross Trading Strategy

The first strategy that I gave you was the simplest way to trade the RSI. This is the version that I learned way back when I was first learning to trade.

You can get the complete RSICross trading plan here. 

From a logical point of view, this strategy makes a lot of sense.

The RSI indicator detects instances where price is at an extreme…over the last X number of candles.

So it makes sense that you could probably catch a few price reversals that way.

But we're interested in data and not theories, so let's get into the numbers…

Backtesting Results

(Screenshot from Forex Tester)

Here are the results from this specific trading plan:

• Currency pair: EURUSD
• Chart timeframe: Daily
• Number of days tested: 6,032
• Number of trades: 102
• Win rate: 44%
• Return: -11.38% 
• Max consecutive winners: 3
• Max consecutive losses: 5

So if you followed this strategy from some random blog post you found on the internet, my testing shows that you would have lost over 11% over 16 years.

Obviously, it's good to know that the strategy doesn't have an edge, before you invest time, energy and money into the strategy.

Thoughts on the RSICross Strategy

This just goes to show that ideas that seem logical don't always work in trading.

It's really important that you test and find out for yourself. 

Even though this specific strategy didn't work, there may be other versions of this strategy could work.

Here are some ideas:

• One idea would be to increase the lookback period so trades are being taken on more extreme moves.
• Dropping down to a lower timeframe could also potentially improve results.
• Targeting a larger profit target can improve the return on some trading strategies.
• Using some sort of pyramiding technique could help this strategy increase the return per winning trade.

Stay tuned for more RSI tests in the future. 

Alright, now let's move on…

RSIDive Trading Strategy

The next commonly taught strategy is RSI divergence. I named this strategy the RSIDive, for my own testing purposes.

You can get the complete RSIDive trading plan here. 

I had done some RSI divergence testing before, so I knew that this strategy would probably show positive expectancy.

But you never know until you actually do the test…

Backtesting Results

(Screenshot from Forex Tester)

Here are the results from this specific trading plan:

• Currency pair: EURUSD
• Chart timeframe: Daily
• Number of days tested: 6,032
• Number of trades: 26
• Win rate: 73%
• Return: +12.8% 
• Max consecutive winners: 7
• Max consecutive losses: 2

Now we're talking! 

There are two things that you probably notice about these results.

First, the average monthly return is pretty low.

However, remember that this was just one currency pair on one chart timeframe.

You can test more pairs on more timeframes to potentially boost the overall return.

Second, this strategy looks quite reliable.

The win rate is high and it never lost more than 2 trades in a row.

That's fantastic.

Now that may not happen exactly in live trading, but the potential is there, based on historical data.

So all-in-all, this is a strategy that is worth testing further. I like this strategy and am currently doing more testing on it.

Thoughts on the RSIDive Strategy

Since this is a fairly high win rate strategy, there are things that could possibly be done to increase the return:

• Add a pyramiding element to the entry
• Increase the profit target
• Add a second position to capture the big runs

Keep an eye out for more RSI divergence tests in future blog posts.

If you want to sign up for the email list and be updated on future test results, click the button below.

You will also get a free book on how to choose the best trading strategy for your personality.

On to the next RSI trading strategy…

RSI50 Trading Strategy

The final RSI strategy is a little different.

This strategy uses the RSI 50 level, instead of the 70/30, like most strategies use.

You can get the complete RSI50 trading plan here. 

I've never done any testing with this flavor of RSI trading, so I didn't know what to expect.

It didn't make logical sense to me, but all that matters is the data.

So let's get into it…

Backtesting Results

(Screenshot from Forex Tester)

Here are the results from this specific trading plan:

• Currency pair: EURUSD
• Chart timeframe: Daily
• Number of days tested: 6,032
• Number of trades: 55
• Win rate: 71%
• Return: +26.05% 
• Max consecutive winners: 7
• Max consecutive losses: 3

OK, I was totally not expecting that!

I was almost sure that this strategy would not work.

It just goes to show that you can't make any judgements about trading strategies until you see some actual data. 

Thoughts on the RSI50 Strategy

Like with the other strategies, this one has a fairly low average return per month.

However, the return can potentially be increased by trading it on more pairs or more timeframes. You can also consider adding a pyramiding element to increase the return per trade.

Even though it was profitable, I'm personally not a huge fan of this strategy. I can see the potential to get whipsawed a lot because you really have to be in tune with the prevailing trend.

So I'm not going to develop this strategy further. 

This is just my own personal preference, at this time. I may choose to work on this strategy in the future. 

It's a perfect example of not trading every strategy out there. Only develop the ones that work with your trading personality.

If you're a trend trading personality and want to do more testing, fire up your favorite backtesting software and work on it yourself.

Conclusion

So two out of the three methods where profitable in backtesting on the EURUSD daily chart.

I wasn't expecting that.

It goes to show that backtesting is the most efficient way to find out if a strategy has an edge. Imagine if you invested hundreds of hours in a demo account to come to the same conclusion.

Backtesting speeds up the process dramatically. There are limitations to backtesting, however it is the best first step in your trading journey.

I'll keep on testing and share my results.

But remember…

My results don't matter. They are simply a starting point for your own exploration.

All that matters are the results that YOU get. After all, you will be the one trading your money…not me.

So take responsibility for your results and start testing for yourself. 

The post RSI Trading Strategy Results: 3 RSI Strategies Backtested appeared first on Trading Heroes.

…and more importantly, which ones will work for YOU? 

This is what I want to help you understand in this 3-part RSI series.

Most blog posts and YouTube videos give you one or two well-chosen examples and expect you to believe that a certain RSI trading strategy will work for everyone.

That's simply not true. 

The reality is that a strategy has to match your personality and lifestyle for you to be successful with it.

So don't trust that any strategy you find on the internet will work for you.

In this post, I'll give you 3 complete RSI trading strategies.

Test them for yourself. Here's how to get started with testing.

…and in the next post, I'll show you my testing results.

Before we get started, here are two related blog posts:

• Part 1: The RSI indicator explained
• Download the free trading plan worksheet PDF

Now that you have some basic information, let's dig into 3 popular RSI trading methods that can be found all over the internet.

Vanilla RSI Explained

Let's start with the “vanilla” RSI trading strategy. The idea behind the RSI is that it shows you times when price is “overbought” or “oversold.”

So as the theory goes, you should go long when price is oversold and go short when price is overbought, because price is likely to reverse.

This is a “reversion to the mean” type trade.

Most blog posts will tell you to enter a trade once RSI enters back into the channel. But this is where most blog posts stop.

So now let's take it one step further and formulate a complete trading plan from this idea.

Vanilla RSI Trading Plan

Based on what I have read on the internet about this RSI trading idea, here's a plan that I came up with:

• Strategy name: RSICross
• Version: 1
• Currency pair: EURUSD
• Strategy timeframe: Daily chart
• % Risk per trade: 1%
• Stop loss: Other side of last price swing
• Profit target: 1R
• Indicators used (with settings): RSI (14 period, 70/30 levels)
• Entry rules: 
  • Look for overbought or oversold condition
  • Open trade when RSI closes back inside RSI channel
• Trade management rules: 
  • 1 position at a time, no stacking
  • Set and forget, no moving of stop

I'm using a 1R profit target because it's a quick and dirty way to see if a strategy has an advantage. It also gives us a definitive profit target.

Some exit methods, like targeting the next support/resistance level can be very arbitrary and will vary from trader to trader.

It's true that some strategies do require a larger profit target to be profitable, but since this is our first test, let's eliminate as many variables as possible.

Simple enough right?

If you don't want to wait around for my next blog post, go ahead and test this for yourself with software like Forex Tester. If you feel that I missed anything in this plan, leave a comment at the end of this post.

RSI Divergence Explained

Another common RSI trading strategy on the interwebs is to use price/RSI divergence to enter trades.

For a short trade, you wait for RSI to close outside of the channel. Then look for price to form a higher high, when RSI has formed a lower high.

…and the opposite for a long trade.

Here's what long entry signal would look like:

…at least that's the theory.

Again, the chart above is a well chosen example. The internet is full of them.

The real key to making it work is in the trading plan and the testing process.

RSI Divergence Trading Plan

• Strategy name: RSIDive
• Version: 2
• Primary timeframe: Daily
• Currency pair: EURUSD
• % Risk per trade: 1%
• Stop loss: Other side of last price swing
• Profit target: 1R
• Indicators used (with settings): RSI (14 period, 70/30 levels)
• Entry rules:
  • Look for overbought or oversold condition
  • Look for divergence between RSI and price
  • Avoid trades in heavy trends
  • Look for good separation between the price peaks
  • Open trade when there is a strong candle in the direction of the trade and RSI “hooks.”
• Trade management rules:
  • Trade 1 position at a time, no stacking
  • Set and forget

If you like this strategy, feel free to test it for yourself. Otherwise, keep an eye out for my next blog post.

RSI 50 Crossover

The final common RSI trading strategy is the 50 level crossover.

Unlike the previous 2 strategies, we use the 50 level on the RSI as a confirmation of a trend. So when we think that a trend is in place, we take a short trade when price closes below the 50 and a long trade when it closes above.

This strategy is a bit more subjective because it can be tough to know when price is trending. I can see the potential to get whipsawed a lot.

But I'll give it a go anyway.

Here's an example of a long trade…

RSI 50 Crossover Trading Plan

• Strategy name: RSI50
• Version: 1
• Primary timeframe: Daily
• Currency pair: EURUSD
• % Risk per trade: 1%
• Stop loss: Other side of last minor price swing
• Profit target: 1R
• Indicators used (with settings): RSI (14 period, 50 level)
• Entry rules:
  • Look for strong price trend
  • Enter trade when price closes on the other side of the 50 RSI level
• Trade management rules:
  • Trade 1 position at a time, no stacking
  • Set and forget

Conclusion

Will all of these trading strategies be profitable in backtesting?

Maybe.

…or maybe none of them will be.

That's why we test before ever risking real money with a strategy. 

Stick around for the next post, where I give you the exact stats on how these trading plans test out.

Which RSI trading methods do you think will be profitable? Leave a comment below with your guess or post your own test result.

Disclaimer: Some links on this page are affiliate links. We do make a commission if you purchase through these links, but it does not cost you anything extra and we only promote products and services that we wholeheartedly believe in. TradingHeroes.com is a participant in the Amazon Services LLC Associates Program, an affiliate advertising program designed to provide a means for sites to earn advertising fees by advertising and linking to Amazon.com.

The post RSI Trading Strategies: 3 Complete Trading Plans appeared first on Trading Heroes.

The Relative Strength Index (RSI) is one of the most well known trading indicators in the world.

It's available on almost all trading platforms and is used by professional traders.

So if you want to learn more about how to trade with this indicator, this tutorial will give you the history of the strategy, how it's calculated and trading strategies that utilize the RSI.

Alright, let's get into it!

Brief History of the RSI Indicator Creator

Before we jump into the details of the indicator itself, here's a quick background on the creator of the RSI, because it's an interesting story.

J. Welles Wilder Jr. was born in 1935 in Norris, Texas.

He attended North Carolina State University, where he studied mechanical engineering.

After graduating, Wilder served in the United States Air Force as a fighter pilot.

Wilder became a mechanical engineer, then a real estate developer. He later became intrigued by technical analysis in the financial markets.

In 1978, he published his groundbreaking book “New Concepts in Technical Trading Systems.”

This book introduced the Relative Strength Index (RSI) along with other technical indicators such as the Average True Range (ATR) and the Parabolic SAR (Stop and Reverse).

The RSI quickly gained popularity among traders and investors for its ability to identify overbought and oversold conditions in financial markets.

Wilder's contributions to technical analysis revolutionized the way traders analyze markets and make trading decisions.

Throughout his career, Wilder continued to develop and refine trading indicators and systems.

He also founded the Delta Society International, an organization dedicated to the study and application of technical analysis in trading.

The Delta Phenomenon is one of Wilder's most interesting books. In it, he shares his research indicating that all markets have a hidden order.

Wilder's innovative work in technical analysis earned him widespread recognition and accolades within the financial industry.

He passed away in 2021, leaving behind a lasting legacy as a pioneer in the field of technical trading.

Now that you know a little about the creator, let's take a look at the indicator itself.

The Core Principles of the Relative Strength Index

Traders use the RSI to identify potential trend reversals and confirm the strength of a prevailing trend.

It can potentially be used in any trading market, but must always be backtested before trading real money.

Extreme RSI readings can signal potential buying or selling opportunities, as they suggest that a market may be overextended and due for a correction.

Additionally, divergences between price movements and RSI values can provide insight into underlying market dynamics and potential changes in momentum.

Key components of the RSI include:

• RSI Formula: The RSI is calculated using a two-part formula, which is explained in detail below.
• Overbought & Oversold Thresholds: The default settings are 70 (overbought) and 30 (oversold) as potential signals for price reversals. However, these settings can be changed to generate fewer signals (greater than 70 and less than 30), or more signals (less than 70 and greater than 30).
• Divergence: When the RSI diverges from the current price trend, it indicates that the current trend may be weakening.
• RSI Periods: By default, the RSI is typically set to a period of 14. However, this can be adjusted to increase sensitivity (with a lower period) or decrease it (with a higher period).

The RSI is usually beneficial when used in conjunction with other technical analysis tools.

Here's what the RSI looks like on a chart:

RSI Strengths

• Since most markets usually trade in ranges, the RSI can be a good tool for taking advantage of reversal moves within a range
• The indicator is easy to understand
• This indicator is widely available

RSI Weaknesses

• The RSI can create many false signals in a strongly trending market
• An overbought or oversold signal does not guarantee that the market will reverse
• Like any other indicator or trading strategy, it takes time to master and needs to be backtested before using

Where to Get the RSI Indicator

The RSI is available on most charting platforms.

In fact, all of the charting platforms I've used had the RSI.

I would recommend using the RSI on TradingView, but use whatever charting software works for you.

How to Get RSI Alerts

If you don't have time to monitor the markets, then a platform that has RSI alerts is very valuable. 

They will send alerts to your phone so you don't miss a signal.

Some platforms require you to install a custom indicator, while other platforms have alert capabilities built in.

That's why I recommend using TradingView.

It has RSI alerts built in.

Another way that you can get alerts is to use my custom indicator for MetaTrader 4.

Other platforms also have solutions, so find out what's available on your favorite trading platform.

RSI Trading Strategies

There  are several ways to use the RSI to trade. 

I'll be covering each method in more detail in future articles and I'll also backtest as many strategies as possible.

Here's a list of the common trading strategies that use the RSI:

• Overbought/oversold
• RSI Divergence
• RSI exit strategy
• Connors RSI 2
• Midline crosses
• Swing 5

You can learn more about each variation in this tutorial.

Now let's take a closer look at the RSI calculation.

RSI Indicator Calculation

The way that RSI is explained in most books and on most websites is a little confusing.

So I created a graphic that clears up the confusion and shows you exactly how the RSI calculation formula works.

Alright, now that you know the formula, let's break down each component.

First, let's start with the variables.

Number of Periods (n) or Length

n is one of the settings that you would use in charting platforms like TradingView, NakedMarkets or MetaTrader.

It's basically the number of periods that you want to look back on the chart to determine the current RSI value.

The default value is usually 14 periods, but it can be changed, according to what you want to achieve.

When the RSI is set to 14, your charting software will calculate the current RSI value based on the last 14 periods.

Many websites refer to the default RSI setting as 14 days, but that's only if you are trading on the daily chart. The RSI look back can also be measured in weeks, hours or minutes. 

It just depends on what timeframe chart you are using the indicator on.

Therefore, I will refer to the RSI look back setting in periods, which is more accurate.

Your RSI period setting will depend on your goals and your trading strategy.

There's no right or wrong answer here.

It just depends on what you have tested and what is profitable for you.

Relative Strength (RS) First Data Point

The raw Relative Strength number simply shows you how current price compares to historical prices over the last n periods.

It can be a little tough to understand what that number is actually telling you.

So Wilder's formula turns the number into an index that stays between zero and 100.

Therefore, the RSI is an oscillator because it goes back and forth on a fixed scale between 0 and 100.

Having a set scale allows RSI to be easily used across any trading instrument.

It's also a momentum indicator because its goal is to show traders when momentum could be slowing down.

The first RSI graph point is calculated by summing the up periods and dividing the result by the n periods setting in the RSI indicator.

That number is then divided by the average of the down periods over the last n periods.

For example, let's say that you are trading the daily chart and n is set to 5.

The last 5 days are as follows:

1. 10 pips up
2. 20 pips down
3. 100 pips up
4. 30 pips down
5. 200 pips up

In order to calculate the numerator, you would average the up days: 10 + 100 + 200 = 310 / 5 = 62

Then you would calculate the denominator with the down days: 20 + 30 = 50 / 5 = 10

Finally, you would divide the numbers to get: 62 / 10 = 6.2

Therefore: RS = 6.2

Converting RS into RSI

From there, you would turn RS into RSI by doing the following.

So starting from the right side of the equation: 100 / (1+ 6.2) = 13.8

Then: 100 – 13.8 = 86.2

Which means: RSI = 86.2 

Subsequent RS Calculations

After the first RSI data point, all of the following data points are calculated with this modified formula.

This formula is similar to an exponential or weighted moving average, in that it gives more weight (importance) to the current RS reading.

So you would start by averaging the first n-1 periods for both up and down moves.

Then you would add in the current average for up and down moves to their respective averages and divide each total by n.

Let's use the data from the previous example and add in a 6th period, to show you how this works.

1. 10 pips up
2. 20 pips down
3. 100 pips up
4. 30 pips down
5. 200 pips up
6. 30 pips down

First, you would average the first 5 (n-1) up periods:

100 + 200 = 300 / 5 = 60

Then you would multiply the average by n-1 or 5:

60 * 5 = 300

Now we do the same for the denominator:

20 + 30 = 50 / 5 = 10 10 * 5 = 50

Next, average the data from the previous 5 periods, plus the 6th period.

Since the 6th period is a down period, nothing would be added to the up periods calculation:

300 + 0 = 300 / 6 = 50

Add in the 6th period down move, then average by 6:

20 + 30 + 30 = 80 / 6 = 13.3

Then RS is:

50 / 13.3 = 3.75

RS = 3.75

Converting RS into RSI

Again, we do the RSI calculation to convert the RS to RSI:

100 / (1+3.75) = 21 100 – 21 = 79

RSI = 79 

RSI Signal Levels

As mentioned above, the default signal levels are usually 30 and 70.

But some traders will use different settings, depending on what they want to achieve.

Other common settings are:

• 20/80
• 10/90

This is where to find the signal levels on a chart.

If the RSI is over 70, price is considered overbought and is a potential sell signal.

On the opposite side, when the RSI goes below 30, that's a potential buy.

The concept is simple, but it takes testing and practice to master.

Common RSI Misconceptions

A few websites will tell you that a longer look back period is more “accurate.”

This is simply not true.

A shorter look back period will make the RSI more sensitive, which can work well for certain trading strategies.

A longer period may work better for other strategies.

Always test your strategy with different RSI settings and find out what really works for you.

Never take anyone's word at face value, always test it for yourself.

Other people on the internet will tell you that the RSI is a lagging indicator, so it's not useful.

The bottom line is that professional traders use the RSI.

Larry Connors is one trader who is well known for developing RSI trading strategies and has published his research.

Final Thoughts on the RSI Indicator

So that's how to RSI works and what it can tell you about a market.

Like with any other indicator, it has strengths and weaknesses.

This indicator is not for everyone, but if you like the idea of using this indicator, you should certainly look into it.

Review the different trading strategies that use the RSI, pick your favorite, then start backtesting.

The post RSI Indicator Explained: Calculation and Definition appeared first on Trading Heroes.

Which RSI trading strategy is best?

The little-talked-about reality is that there is no one magic RSI strategy that works for everyone.

Yes, traders do use the RSI successfully. 

But the key is that they have all customized it to suit their personality and the market they trade. 

It can potentially be used in any trading market and it's a very flexible strategy that can be used in several different ways.

You have to review the RSI trading strategy options, pick a couple that make sense to you, then backtest them throughly to find out if each one has an edge.

If a strategy isn't profitable, you can experiment with the settings and inputs to see if you can make it profitable.

Even after you have a successful backtest, you can continue to work on optimizing the strategy to make it line up with your goals.

So in this article, I'm going to give you a list of all of the RSI trading strategies that I know about, so you can start this process for yourself. 

I'll also include some of my own backtesting results and give you links to RSI related resources that you can use to become a RSI expert.

Alright, if you're ready to become a RSI ninja, let's get into it.

RSI History and Calculation

Before I get into the actual strategies, if you're new to RSI trading, then take a minute to read about who invented it and how this indicator is calculated.

This may seem a little boring, but it's very important to understand the benefits and limitations of the RSI.

Knowing how RSI is calculated and what it tells you will allow you to get the most out of it. 

I've written a complete breakdown of the RSI here.

Now let's get into the actual strategies.

RSI Overbought/Oversold Trading Strategy

The traditional use of the RSI is to identify potential turning points on the market.

When the indicator goes oversold, that can mean that too many traders are short and the market is ready for a reversal.

On the other hand, when RSI is overbought that can mean that too many traders are long.

In other words, this is a countertrend trading strategy that looks to trade trend reversals.

Indicator Settings

The most commonly taught use of the RSI Overbought/Oversold Strategy uses the following settings:

• Periods: 14
• Levels: 70/30

Traders usually wait until RSI starts to form a peak or bottom out, before they sell or buy.

Trade Entry

Here's the most common entry:

• Sell: When the RSI peaks above 70
• Buy: When RSI peaks below 30

Short Example

When RSI enters the overbought signal level, you can wait for it to peak to take a short trade.

Long Example

In this example, price had a nice upside run after RSI went into oversold territory.

Of course, not all trades work out this well, but these are examples to illustrate the point.

If you are missing a lot of RSI signals, be sure to check out our standard RSI alert indicator for MT4.

Stop Loss and Take Profit

The stop loss is set above or below the last swing high/low.

A good take profit is the next support or resistance level, but you can experiment with different levels to see what works best for you.

Here's an example short trade.

Potential Improvements

You can (and should) backtest this strategy as-is.

But if you're looking for ways to optimize this strategy then I'm also going to give you methods to potentially to improve you results.

Remember that all improvements should be backtested and do not guarantee better results. 

They are just ideas that you can use to experiment with your strategy. 

Here are a few things that you can try:

• Take a trade as soon as RSI closes inside the signal levels
• Change the periods setting
• Only take trades when price is at clear support or resistance
• Change the signal levels to 80/20 or 90/10 to potentially weed out noisy signals
• Use another indicator in conjunction with RSI to improve win rate or profit per trade
• Set the profit target to a multiple of risk

RSI Divergence Trading Strategy

Another way that you can use RSI is as a divergence indicator.

This means that if you spot RSI trending in the opposite direction of price, it's a possible signal that price is going to reverse.

To learn more about RSI Divergence, read this article.

Indicator Settings

The most commonly taught use of the RSI uses the following settings:

• Periods: 14
• Levels: 70/30

Trade Entry

Here's the most common entry:

• Sell: When price shows a second higher peak, but RSI shows a lower peak and the first peak is overbought
• Buy: When price shows a second lower peak, but RSI shows a higher peak and the first peak is oversold

Short Example

So in the chart above, the blue line on the chart shows the two price peaks going higher, while the RSI peaks are going lower.

This signals a possible reversal of the uptrend.

As you can see, price does drop from this point, but depending on your profit target, it may not have been enough to hit your profit target.

There are at least two other divergences on this chart.

Can you spot them?

These signals can be hard to spot, so it's very useful to have a RSI divergence indicator.

Long Example

Stop Loss and Take Profit

The stop loss usually goes above the second high for a short and below the second low for a long.

As far as the take profit, a good place to set it is the next support or resistance level.

Potential Improvements

Here are a few things that you can try:

• Change the periods setting
• Change the signal levels to 80/20 or 90/10 to potentially weed out noisy signals
• Use another indicator in conjunction with RSI to improve win rate or profit per trade
• Set the profit target to a multiple of risk
• Take trades even when RSI doesn't go into overbought and oversold

RSI Exit Trading Strategy

As you know, when you get into a big trend, RSI can stay overbought or oversold for a long time.

This can lead to big losses if you continue to fight it and you don't have something like a 2-Strikes Rule.

So an alternative to entering a trade when RSI hits the signal level and starts to turn, is to enter the trade when RSI exits the signal level.

This may mean that you catch the entry late, but it makes it much less likely that you will be fighting a big trend.

Indicator Settings

The most commonly taught use of the RSI uses the following settings:

• Periods: 14
• Levels: 70/30

Traders usually wait until RSI starts to form a peak or bottom out, before they sell or buy.

Trade Entry

Here's the most common entry:

• Sell: When the RSI gets above 70, sell after RSI closes below the 70 level
• Buy: When RSI gets below 30, buy after RSI closes above the 30 level

Short Example

Long Example

Stop Loss and Take Profit

The stop loss for this strategy would go below the low for a long and above the high for a short.

Placing the take profit at the next support or resistance level is the best exit to start testing.

Potential Improvements

Here are a few improvements to this strategy you can experiment with:

• Change the periods setting
• Only take trades when price is at clear support or resistance
• Change the signal levels to 80/20 or 90/10 to potentially weed out noisy signals
• Use another indicator in conjunction with RSI to improve win rate or profit per trade
• Set the profit target to a multiple of risk

Larry Connors RSI 2 Trading Strategy

Now we get into a really cool RSI trading technique.

This is the RSI 2 strategy by Larry Connors.

It's also a good example of using a complementary indicator with the RSI.

Basically, the RSI indicator is adjusted to a 2 period setting and the signal levels are moved to 95 and 5.

After that, we use a 200 EMA to determine if we should go long or short.

Above the EMA is long, below is short.

When price hits a RSI trading signal level and is in the right position, with respect to the 200 EMA, then you take a trade. You exit when price closes above (for a long) or below (for a short) a 5 EMA.

All of the long signals are marked in the chart above, with red vertical lines.

Obviously, this is a very short-term strategy.

Indicator Settings

The most commonly taught use of this method uses the following settings:

• RSI periods: 2
• RSI levels: 95/5
• Simple Moving Average: 200
• Simple Moving Average: 5

Trade Entry

• Sell: When RSI is overbought and price closes below the 200 SMA
• Buy: When RSI is oversold and price closes above the 200 SMA

Short Example

Long Example

Stop Loss and Take Profit

There are no stop losses with this strategy.

Connors found (as have I) that this strategy works best without stop losses.

The exit for this strategy is when price closes on the other side of the 5 SMA.

This strategy is more of a short term strategy that closes trades fairly quickly.

Potential Improvements

Here are a few improvements to this strategy you can experiment with:

• Change the periods setting
• Only take trades when price is at clear support or resistance
• Change the signal levels to 80/20 or 90/10 to potentially weed out noisy signals
• Use another indicator in conjunction with RSI to improve win rate or profit per trade
• Set the profit target to a multiple of risk

Backtesting Results

You can also see my results of a backtest here.

RSI 50 Crossover Trading Strategy

The previous RSI trading methods rely on price extremes to find potential trading ideas.

Of course, trading at extremes can be a great way to get in for cheap.

However, you are also bucking the trend and that can mean that you might get stopped out a lot.

One way to possibly remedy this is to try to catch price when it is starting to trend.

For this strategy you set your levels both to 50, then enter a trade when RSI closes above or below the 50 level.

Indicator Settings

The most commonly taught use of the RSI uses the following settings:

• Periods: 14
• Set both levels to 50

Trade Entry

• Sell: When RSI has stayed above the 50 for awhile, go short when RSI closes below the 50 level
• Buy: When RSI has stayed below the 50 for awhile, go long when RSI closes above the 50 level

Short Example

Long Example

Stop Loss and Take Profit

The best place to set the stop would be above the last swing high for a short, or below the last swing low for a long.

Like with all of these strategies, a good place to start with the profit target at the next support or resistance level.

Potential Improvements

Here are a few improvements to this strategy you can experiment with:

• Change the periods setting
• Only take trades when price is bouncing off clear support or resistance
• Use another indicator in conjunction with RSI to improve win rate or profit per trade
• Set the profit target to a multiple of risk
• Look for reversal price action like a head and shoulders or double top/bottom before the crossover

Final Thoughts

So I hope that these RSI ideas have given you a few things that you can test.

Remember, there isn't one best way to trade the RSI.

You have to find the one that works best for you and the markets you trade. 

But sometimes you just need a few ideas to get your creative juices flowing.

The next step after reading this article is to start backtesting your RSI trading strategy.

Have fun!

The post RSI Trading Strategies Guide appeared first on Trading Heroes.

The Relative Strength Index or RSI was developed by J. Welles Wilder and published in his book New Concepts in Technical Trading Systems, in 1978. It is one of the most well known and widely used indicators. It is included in almost every charting software on the market today.

But you may not know exactly how this indicator works or how it can be used. This post will get into how it is calculated and a few different ways that it can be utilized to execute trades.

The Calculation

RSI is a momentum oscillator, meaning that it measures directional price momentum and moves between a minimum of 0 and a maximum of 100.

It is calculated as follows:

RSI = 100/ 100-(1+RS)

Where RS = average gain / average loss

The recommended setting for this indicator is 14. So all of our examples will be shown over 14 periods.

RS is a little confusing, so let's clarify it. The most recent period is calculated in the following way.

The most recent average gain is calculated like this:

Average Gain = Sum of Gains over the past 14 periods / 14

A gain is defined as a period where the close is higher than the open.

The most recent average loss is calculated like this:

Average Loss = Sum of Losses over the past 14 periods / 14

A loss is defined as a period where the close is lower than the open.

After the most recent calculation, the following 13 periods are calculated like this:

• Average Gain = [(previous Average Gain) x 13 + current Gain] / 14
• Average Loss = [(previous Average Loss) x 13 + current Loss] / 14

So the most recent price action carries more weight in the calculation. This is similar to how an exponential moving average is calculated.

But that is only the RS calculation. The rest of the equation normalizes the indicator so that it oscillates between 0 and 100. When the indicator is 100, all 14 periods were gainers and when the indicator is 0, all periods were losers.

How to Use the RSI Indicator in Forex

The purpose of the indicator is to alert traders to possible overbought or oversold conditions on the chart. This potentially signals turning points in the market.

The default overbought setting is 70 and the default oversold setting is 30. Whenever the RSI hits 30, it represents a possible buying opportunity and when it hits 70, it is a possible sell opportunity.

Just like with any other indicator, it will not be 100% accurate. It only represents an opportunity. You will have to use your judgement as to when to take a trade.

When It Doesn't Work

In strongly trending markets, RSI can stay overbought and oversold for extended periods of time. If you were to take every single signal in these conditions, it would lead to huge losses.

For example, take this EURCAD chart. If you too every single overbought signal, it would have resulted in at least six losses and probably more.

Therefore, if you are using the RSI for Forex trading, your risk management plan must include a contingency for limiting losses in a strongly trending market. Limiting the number of consecutive losses or a maximum percentage loss are two ways to do it.

You can also use concepts such as divergence and support/resistance to try to find the very best signals. Let's take a look at how this works.

Divergence Between RSI and Price

The first way that you can potentially filter out lower quality signals is by combining the concept of divergence with overbought and oversold conditions. This may filter out false signals, but may also cause you to miss out on opportunities. Thus is the nature of trading, there are no free lunches.

In the chart above, price continues to move higher while RSI makes lower highs. This ultimately signals a drop in price. Again, this will not happen all the time, but it can give you a clue as to what is about to happen.

Support And Resistance

Finally, support and resistance within the RSI itself can be used to signal the end of a trend. Let's look at the strongly trending chart that we saw before, but from a support and resistance point of view.

While price is in a trend, you will notice that RSI continually runs into resistance until breaks out and resistance becomes support. This signals a turn in price and an end of the trend.

You will also notice that there was a false breakout, but the RSI did not stay above the resistance line. Even if you took a trade on the false breakout, you probably would have been able to make the loss back on the next break.

Conclusion

So that is how the RSI indicator works. Some people tend to dismiss it because it is so simple. But often the simplest tools are the best.

It isn't perfect, but with some practice and testing, it might work for you. I would recommend exploring it and seeing if it fits your personality. Never trade it live without testing and demo trading it.

If you would like to get alerts in Metatrader 4, whenever RSI goes to overbought or oversold, purchase our Simple MT4 RSI Alert indicator. You can get alerts on your screen, audio sound on your computer, email, text message or push notification on your smartphone.

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