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Testing out the Relative Strength Index Indicator (RSI).

The Relative Strength Index (RSI) indicator is one of the most popular indicators at the disposal of traders across the globe. Why is it so popular?  The use of it is radically simple, but can be used in different ways.  In fact, it is quite intuitive because of finite limits that are not necessarily present in other indicators like CCI and MACD.  However, does it bring effective results and what ways do traders use this indicator?

What is the Relative Strength Index (RSI)?

The Relative Strength Index is used to measure the overbought or oversold nature of a security or currency pair.  Defining overbought or oversold does reach into some debatable territory for this indicator, which means that those new to this indicator need to first look at the indicator itself before making a judgment.

This indicator goes from 0 to 100.  0 being that the security or currency pair is at its absolute oversold state and 100 being that the security or currency pair is at its absolute overbought state.  The dispute is as to where the oversold and overbought zones start.

There are four camps in the dispute and what you as an algo builder (you are not manually trading) have to determine is which one works best during testing and provides enough trading frequency to be a part of your strategy portfolio.

Camp #1:  Oversold Levels start at 33.33 and Overbought Levels start at 66.66.

Camp #2:  Oversold Levels start at 30 and Overbought Levels start at 70.

Camp #3:  Oversold Levels start at 20 and Overbought Levels start at 80.

Camp #4:  Oversold Levels start at 10 and Overbought Levels start at 90.

While the fourth camp may seem extreme, it is not if you trade on lower timeframes and choose a low RSI period.  There's no one "right" way to interpret technical indicators, the "right" way is the one that generates profits with drawdowns that fit your risk aversion level.

RSI can be used in different ways:

  1. As a trend strength confirming filter.
  2. As a catalyst to signifying a change a trend.  If the 50 Line is crossed, there is a change in trend.  If the price exits an oversold or overbought zone, it can be considered a trend shift.
  3. Divergence and Convergence as it applies to the actual mapping of prices.
  4. As a non-price specific exit tool.

Relative Strength Index Strategy #1:  RSI + MACD

Timeframe:  4 Hours

Indicators:  RSI 12 period, MACD (12, 26, 9).

Buy Entry:

  • RSI is between 30 and 60.
  • MACD Signal is greater than Histogram.

Sell Entry:

  • RSI is between 40 and 70.
  • MACD Signal is less than than Histogram.

Buy Exit:  RSI goes above 70 OR MACD Signal is less than Histogram.

Sell Exit:  RSI goes below 30 OR MACD Signal is greater than Histogram.

Relative Strength Index Strategy #2:  RSI + Pivot Points

Indicators:  RSI 10, RSI 5, Pivot Points

Timeframe:  1 Hour

Long Entry:

  • RSI 10 is rising above 30 and RSI 5 is rising above 20.
  • The High is below Support Level 1.

Short Entry:

  • RSI 10 is falling below 70 and RSI is falling below 80.
  • The Low is above Resistance Level 1.

Long Exit:  RSI 10 is 70 or above.

Short Exit:  RSI 10 is 30 or below.

Relative Strength Index Strategy #3:  RSI + Supply and Demand Avoidance

Indicators:  RSI period 10, RSI period 5.

Timeframes:  1 Hour and 4 Hour

Long Entry:

  • RSI 10 is rising above 30 and RSI 5 is rising above 20.
  • The previous candle is not inside any Supply and Demand Zone.

Short Entry:

  • RSI 10 is falling below 70 and RSI is falling below 80.
  • The previous candle is not inside any Supply and Demand Zone.

Long Exit:  RSI 10 is 70 or above.

Short Exit:  RSI 10 is 30 or below.

EURUSD 1 Hour Chart

USDJPY 1 Hour Chart 

EURUSD 4 Hour Chart

USDJPY 4 Hour Chart

Relative Strength Index Scratching the Surface

This is just getting started with the Relative Strength Index.  There are many possibilities with this indicator and the only way to test them out is to automate because there's not enough time otherwise.  The Relative Strength Index would make a good addition to many different strategies and it is up to you to figure it out.