The relative strength index is the most popular momentum indicator. It measures the speed in the change of price movement ranging from 0 to 100. According to the developer of the RSI, J. Welles Wilder, the currency pair is considered oversold when under 30 and overbought when over 70.
How is it calculated?
It is not necessary to know how it is calculated but it will give your a better idea how to use the RSI to your advantage.
With RS= Average gain of up periods/ Average loss of down periods during a specific time frame
How to use the RSI
The simplest way to trade using RSI is to buy when the currency pair is oversold and sell when the pair is overbought.
Using the RSI this way can cause false signals during a strong trend where the RSI could stay below oversold or above overbought for a long period of time, one way to avoid losing out to false signals would be to wait for the RSI to cross back from oversold or overbought. For example if the pair has crosses over 70 don’t sell until it has dropped back below the 70 confirming a possible change in trend.
Another way is to use divergence. this is when there is a difference between the price chart and the RSI chart. in a bearish divergence the price will make a new high but the RSI doesn’t, this is a good sell signal. A bullish divergence signal is when the price make new lows but the RSI does not giving a good buy signal.
Which ever way you choose to use RSI, it is best to use in conjunction with other technical analysis techniques for confirmation of a trade. Also correctly placing stop losses incase of extended overbought or oversold conditions will help reduce losses due to false signals.