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The relative strength index or RSI is a moment oscillator which is used to measure the speed and magnitude of directional price movements. The indicator will help you determine overbought / oversold levels, as well as provide you with buying and selling signals.
The RSI indicator with standard settings
The RSI is basically a single line that fluctuates in a corridor between 0 and 100. The closer the line approaches the zero mark, the greater the possibility that the asset will be oversold.
When the RSI approaches 100, the asset is probably overbought. According to the indicator, the price of the asset can be appreciated once it reaches the oversold zone and depreciates once it reaches the overbought area.
How to use the RSI indicator to operate?
As indicated above, the RSI ranges from 0 to 100%. Traditionally, the RSI is considered overbought when it is above 70% and oversold when it is below 30%. If the indicator provides many false alarms, it is possible to increase the overbought limit to 80 and decrease the oversold limit to 20.
Buy and sell signals provided by the RSI
J. Welles Wilder recommended a smooth period of 14, which of course can be changed to adapt to short and long-term strategies. Shorter or longer periods are used for shorter and longer forecasts respectively.
The RSI is a universal indicator and can be used for the purpose of trading any asset from Forex to cryptocurrencies and securities.
Keep in mind that during strong trends, the RSI may remain in the oversold / overbought areas for quite some time!
RSI Settings and Settings
To use the Relative Strength Index, you just have to do the following:
Optional: modify the settings. By creating the indicator, you can adjust the period and overbought and oversold levels for greater sensitivity / accuracy. Remember the wider the corridor, the smaller the signals you get, but at the same time they will be more precise. Otherwise, if the limit levels are close to each other: the crosses of the signals will appear more often, but the number of false alarms will also increase. Remember that increasing the parameter "Period" is making the indicator less sensitive.
Standard approach – 70/30
A smoothed period of 14, oversold level of 30% and overbought level of 70% are the standard approach. This is the preset setting of the most frequently used indicator. Traders expect the RSI to bounce from the 30 and 70 limit lines. With standard parameters this will happen very often, but it will not always mean that a real change in the direction of the trend is approaching.
Conservative approach – 80/20
A softened period of 21, oversold level of 20% and overbought level of 80%, are those recommended by supporters of the conservative approach. Investors with risk aversion use an adjustment of the indicator so that the RSI is less sensitive and therefore minimize the number of incorrect signals. More extreme levels of maximums and minima – 90 and 10 – occur less frequently but indicate stronger impulses.
Divergence is another way of using the aforementioned indicator. If the movement in underlying prices is not confirmed by the RSI, it may indicate a change in the trend.
The divergence is a sign of a close price inversion
Divergence can be a good indicator of a future price inversion. In the previous example, the price of the asset falls, while the RSI shows the opposite movement. This situation is followed by a change in the trend.
The RSI is a powerful tool that can help you determine points of entry and exit. Sometimes you can also predict the trend that other indicators are too slow to discover. However, it is rarely used by itself and must be combined with other indicators (for example, the Bollinger Bands or the Alligator).
Any reference to movements or historical price levels is informative and is based on external analysis and we do not guarantee that such movements or levels can happen again in the future
DISCLOSURE OF RISKS
Product difficult to understand, the CNMV has determined that it is not suitable for small investors, due to the complexity and high risk involved.
Source: IQOption blog (blog.iqoption.com)