What is RSI indicator | How to Use & Read Relative Strength Index

The relative strength index is a momentum oscillator widely employed in technical analysis. Many Forex trading strategies for beginners use it as a tool to confirm buy or sell signals. RSI works like a Stochastic oscillator, Moving Average Convergence Divergence (MACD), and CCI. There also used the modifications, such as Silent RSI, RSI Divergence, and others.

The article covers the following subjects:

The article is going to be useful, engaging, and to the point!

What is the RSI in Stocks: Definition & History

The Relative Strength Index (RSI) was developed by J. Welles Wilder, the author of another standard indicator for МТ4 and МТ5, the ATR indicator.

Wilder first published the description of the RSI indicator in Commodities magazine in 1978. A few years later, his book New Concepts in Technical Trading Systems was published, where he described the technical tool in more detail, using practical examples.

Here you can see how RSI works on the chart:

• The stronger are the relative price movements up, the greater is the total value of rising candlesticks, and the stronger is the uptrend. The RSI trendline is close to value 100.

• The stronger are the relative price moves down, the greater is the total value of descending candlesticks. So, the stronger is the downtrend, the closer the RSI trendline to 0.

The RSI line is displayed in a separate window under the trading chart.

Horizontal dotted lines are signal lines, whose parameters are specified in the settings. The values of 30 and 70 are by default; the levels scale is on the right of the RSI chart.

These zones are strong as the trend and the RSI line are the most likely to reverse.

If the trend is clear, the levels of the borders of the range can be moved to 20 and 80. Levels 30 and 70 are used if the trend is weak, or the market is trading flat. The longer is the distance between the signal levels, the less frequent are signals. One the other hand, the signals are more accurate in this case.

You can employ the RSI line in any market. It is equally efficient in the Forex trading charts, in the securities or stock markets.

RSI Indicator Calculation & Formula

What does the RSI indicate? By the RSI meaning, the indicator compares the size of candlesticks (i.e. the trend strength. The longer is the candlestick, the stronger is the trend) within a particular specified period. In general, that is what the rsi indicator buy and sell signals are based on.

RSI indicator formula:

Step 1. The relative strength index calculates the range of the positive (U) and the negative (D) change in the market price action. I will explain the RSI formula below.

• The period closes up, being a rising (positive) period if the current close is higher than the closing price of the previous period.

U = Price(i) – Price(i-1)

D = 0, where

Price (i) is the close recent price (i.e. current candlestick), Price(i-1) is the close of the previous period.

• The period closes down, it is a falling (negative) period if the close recent price is a lower high than the previous close.

U = 0

D = Price(i-1) – Price(i)

If both closing prices are equal, then U = 0, D = 0.

Step 2. Calculation of the relative strength.

RS = SMA(N) of U / SMA(N) of D

This part of the RSI formula means that the values of U and D are smoothed with a Simple Moving Average (SMA) with the N period. One of the sources gives a simplified formula: RS (Relative strength) is the ratio of the average gain to the average loss.

Step 3. Calculation of the RSI indicator

RSI = 100 – (100 /(1 + RS))

This is one of the most common calculation formulas, but not the only one. For example, in adapted versions of the RSI indicator formula, the market recent price change is smoothed using Exponential Moving Averages. The author himself suggested using a Modified Simple Moving SMMA.

Note 1: If you use an SMA in the formula. If the trend lines are steadily rising, without a single down candlestick for the specified period written in the indicator settings, the D value in the RS denominator will be 0. Since you cannot divide by 0, the oscillator value is considered to be 100.

Note 2: The above formula describes the general principle of the index calculation, it is not a constant. According to it, when the period is 2 for an uptrend, the index value must be 100. The actual value in the screenshot below is 89.

If you want to explore the RSI formula and understand in more detail, and you know the MGL programming language, you can open the code. In the MT4 menu, enter the File/Open data folder. In the window that opens, go to the directory “MQL4/Indicators”, find there an mql4 file, and run it. It will open in Word.

RSI Calculation Excel Sheet

I have prepared the relative strength Calculator template for technical analysis. The Excel file includes an algorithm for calculating the Relative Strength Index, you can also draw diagrams using the RSI indicator values you enter.

You can download the RSI calculation excel Sheet here.

Set up and custom RSI

You don’t have to set up the standard version; the oscillator is in almost all trading platforms. It is a little more difficult with the modifications. You have to set them up onto the trading platform yourself. Moreover, the indicator code must be compatible with the trading terminal code. For example, for the MT4 platform, it should be the MQL4 programming language. If the trading platform doesn’t suggest adding other technical indicators, you can’t trade with the RSI’s combined versions. If you want to download a modified version, let me know in the comments section. I will write to you where you can get working templates.

Using the RSI indicator in the trading terminal

Install the Relative Strength Index in the LiteFinance trading terminal:

1. In your profile, open the trading chart of any currency pair. For example, AUDCAD. Click on the trade TRADE on the left menu, go to the Currencies section, and click on the currency pair you need.

2. At the top of the chart, click on the Indicators tab, and choose the RSI Indicator.

It will appear under the price chart. To see the custom window, click on the corresponding icon (marked with the arrow on the screenshot below).

RSI indicator settings:

1. Parameters:

• Length (period). It is the number of candlesticks, which the RSI momentum oscillator analyzes to indicate the average value. The default period is 14. It means that the market price change for the last 14 is considered. If the period is 25, the oscillator analyzes the last 25 candlesticks.
• Source is the type of price that is considered in the formula. By default, it is the close price. You can also set the open price, the high or the low. There are three variants of median prices.
• Accuracy. The levels value the value of the levels with precision to the fourth decimal place. If the parameter 0 is set, the value of the levels is 30, 70, etc. If the parameter is1, levels are 30.0, 70.0, etc.

2. Style:

• RSI line (lines color). You can choose the thickness and the color of the lines, levels, and the fill color between the levels.
• The RSI values of levels (upper limit/lower limit). The default limits in the LiteFinance trading terminal are 30 and 70. You can change them according to your trading technique.
• Enable/Disable indicator lines, levels, fill.

The LiteFinance terminal’s advantage is that you will immediately see any change on the RSI chart next to the settings window. You need to click “OK” or “Apply” to activate other trading platforms’ changes. On the LiteFinance platform, you see the customs’ adjustments immediately without unnecessary keystrokes and the need to call the settings window again.

RSI for MT4

In MT4, you install and configure the Relative Strength Index in a slightly different way from the same procedure for the LiteFinance trading terminal, but the general principle is similar.

1. In MT4, you install and configure this price momentum indicator in a way that is a little different from the same procedure for the LiteFinance trading terminal, but the general principle is similar.

2. Open the custom window:

2.1. Parameters:

• Period is the same as the Length parameter in the LiteFinance terminal. It stands for the number of candlesticks analyzed. The most recent candlesticks are analyzed.
• Apply to – is the price type. Unlike that in the LiteFinance terminal, there are more options. Previous Indicator’s Data and First Indicator’s Data. MT4 allows one to apply indicators not only to the price chart but also to other indicators. If you want to know what this function is for, how you can use it and what the advantages of superimposing one indicator on another are, write in the comments,, and I will explore this matter in a different overview.
• Style includes the thickness and color of the lines.
• Fixed minimum/Fixed maximum. This option sets the chart window in the level range you enter. For example, if you enter the RSI values of 40/60, the indicator window will display only the content between the levels of 40 and 60.

2.2. Levels:

You can set the parameters of the level in this tab: the RSI values, the color, and the style of the lines. A good option is setting additional levels using the Add button.

2.3. Visualization:

 This tab allows you to set the indicator visualization on all timeframes or some of them. 

Drawbacks of the MT4 compared to the LiteFinance terminal:

• To apply the settings, you need to click on the OK button, then call the parameters window again by clicking the right mouse button and entering the “List of Indicators – Properties” menu. Everything is more straightforward in the LiteFinance terminal. First, all changes to the settings are displayed right there (no need to click OK, which I mentioned above). Second, to open the settings window, just click on the corresponding gear icon next to the chart’s indicator name.
• There is no color fill between the levels.
• You can’t set the levels with the accuracy of a few decimals.

RSI for MT5

In MT5, the Relative Strength Index is set in the same way as in MT4. You go to the Insert menu and open the Indicators tab. The properties window has a few differences:

• The options of Fixed maximum value/Foxed minimum value is moved from the Parameters tab to the new Scale tab.
• The Levels tab is the same as in the MT4.
• There are two new options in the Scale tab: Inherit scale and Scale by line.
• The Visualization tab hasn’t changed. The developers have changed only the visualization of timeframes and added new extended periods.

To sum up, there are hardly any differences between the MT4 and MT5 platforms concerning the installation and customization of the oscillator. 

RSI Trading Strategies

The most popular RSI trading strategies:

1. Building horizontal and diagonal levels and entering trades on the breakout. You draw the level according to the oscillator reference points, which helps you build a similar price chart level. As the indicator sends early signals, you can see the breakout point in advance.
2. Overbought – Oversold (OBOS) Levels. This RSI indicator strategy suggests spotting the trend pivot points. The trend reverses when the market is overheated, and there is an imbalance in the volumes of buy or sell orders. 

   At these moments, the index is in the overbought or oversold levels. If the indicator line goes higher than level 70, you shouldn’t buy the asset.

   The strategy implies that you should wait until the index line reverses in the overbought territory and enter a short trade, according to some additional signals. The same is relevant for entering a long trade when the indicator turns in the oversold levels.

3. Divergence. A bearish divergence or bullish divergence occurs when the indicator line goes in the opposite direction to the price chart. A bullish divergence implies that the price of an asset is making new lows in comparison to the previous low, but the RSI indicator is making higher lows. This indicates that the downtrend may be losing momentum and a reversal could occur. A bearish divergence occurs when the asset price is consistently making new highs but the Relative Strength Index (RSI) is failing to do so, this may signal that the uptrend is losing momentum and that a reversal could be imminent.
4. Failure swing. It occurs when the RSI forms an M or a W pattern. Failure swings show that there is still some buying pressure in the market despite the price decline, which means that the price is likely to continue going up.  You open a position on the price correction after the pattern draws, and the signal level is broken out.
5. Cardwell’s trend confirmations. The strategy employs levels shifted in the price trend lines direction. It suggests entering trades when the indicator reverses and rebounds from the strong levels. The levels for an uptrend are 40 and 80, for a downtrend – 20 and 60.
6. Cardwell’s positive and negative reversals. It is the same as the inverse divergence.

Next, I will explain all the above Forex market RSI strategies and the buy and sell signals. I will also give you real-life examples of how to trade Forex with RSI.

Important: The Relative Strength Index price momentum indicator features common flaws. The signals are lagging, and the indicator repaints. So, the tool mostly serves as an additional confirming tool to supplement trend indicators, technical patterns, etc. Do not enter trades based only on the oscillator signals.

Potential Buy & Sell Signals

The RSI indicator well combines with the classical graphical analysis

It is clear from the screenshot that the price lows coincide with the reference points of the price relative strength at the level of 28. Note that the line breaks through the resistance level earlier than the price actually reverses, signaling the breakout in advance. A sell signal is sent when the oscillator breaks out the level built according to the reference points; it is level 28 in our example. 

Another example, taken from the MT4. The MT4 chart is sometimes more convenient to study historical data.

The thin red ovals mark the reference points of the indicator coinciding with level 30. When the indicator breaks through level 30, there is a trading signal. It is an early signal. According to graphical analysis, the entry would be at the point marked with the green circle.

Notes on the strategy:

• Trade in the short-term timeframes, М15-М30
• The period is less than 14. I used the period of 9 for the EURUSD.
• Zoom out the chart using the scroll or the minus sign. This way, you will extend the period of the chart display without changing the time frame.

 Overbought — Oversold (OBOS) Levels

The relative strength index overbought oversold levels are the signal levels, whose default parameters are 30 and 70. When the index line goes beyond these levels, it means that the market is in the overbought or oversold condition. When the indicator line reverses in these zones, it could signal the change in the trend direction or a deep price correction. However, the trend may go sideways, as in the figures below.

Look for entry points when the lines go back to the range:

• Early signal. The oscillator turns up in the oversold territory or down in the overbought levels.
• Primary signal. When the oscillator breaks out level 70 from the top downward, it’s considered to be a sell signal. If it breaks level 30 from the bottom upward, enter a buy trade.

With the input parameters (14) for the EURUSD pair and the M15 timeframe, four signals appeared. 

The first turned out to be weak, although ultimately, the pullback would not have triggered the stop, and the trade would have yielded a profit. The second one is a perfect trade signal. The third is false. The fourth is true but weak.

Do not strictly follow the default levels parameters of 30 and 70. Use the 5% rule. Find in the daily timeframe the sections where the oscillator’s extreme values for the past three months haven’t lasted more than 5% of the time. Move this level to your trading chart timeframe, revise the level values every 5-10 bars.

Example:

Over the past performance of three months, the indicator hasn’t entered the oversold territory. So, we refer to only the overbought level 76 suits.

We set 76 in the customs and go to the working timeframe. The trades are entered according to the same principle.

The indicator should break through the strong level when it goes outside the overbought or oversold levels.

Notes on the strategy:

• When the RSI crosses the signal level, you enter trades when the price changes in the same direction as the indicator. If the indicator goes against the trend, ignore the signal.

• Do not strictly follow the 5% rule; it is general. Visually estimate the extreme levels, and identify the levels for each market instrument separately.

• Be flexible. The 5% rule reduces the number of signals, but they are more accurate as you enter trades earlier. Find out your optimal combination of the period, levels, and the frequency of signals.

RSI Divergences

Divergence occurs when the indicator and the price chart go in opposite directions due to lagging. The Relative Strength Index is a leading indicator, so the price chart is usually lagging. If the price chart continues the trend, and the signal line has reversed, it is divergence. Divergence signals the trend reversal.

Types of RSI divergence:

You can learn more about the divergence in this overview. Divergence looks like this in the chart:

The signal is the strongest when the divergence occurs while the indicator line is in the overbought readings/oversold zone. A weaker, but still relevant movement is when at least one of the divergence high/low is above level 70 or below level 30.

The above figure displays the bullish divergence. The levels are drawn across two lows; the indicator line hits one of the lows below level 30. The trend reversed up after the divergence.

Notes on the strategy:

• You can spot divergence in any timeframe.
• Highs/Lows on the price and indicator charts should visually coincide.

You enter a trade after the price turns in the direction of the indicator line. The entry point in the screenshot is at the bar that is marked by the arrow.

RSI Failure Swing: Bullish & Bearish

RSI indicator perfectly combines with the Price Action trading strategies. One of the Price Action patterns is a Failure Swing. It is based on the false breakout of a significant High or Low of the previous swing.

• Note. The failure swing strategy suggests entering trades on the local correction and pullbacks at the moment of the primary price rebound. You can learn more in this overview.

When the index is in the overbought/oversold conditions, the oscillator line tries to break through the previous high/low. Next, it turns back to the median level. For the RSI overbought zone, the pattern looks like M; it is a W-shaped for the oversold zone.

There is an M-shaped pattern. The indicator line draws the first top in the RSI overbought zone, turns down, and breaks out level 70. Next, it again tries to test the top, but it makes a lower high which is not explicit.

Buyers can’t repeat the first high. It is clear not only from the movement of the oscillator line but also from the trend character. The candlesticks’ bodies are getting smaller as the price approaches the peak, drawing a Pin Bar pattern. All signals indicate that you can enter a trade at the moment of the trend reversal.

I’ll explain how this method relates to swing trading. I zoom in the chart.

The uptrend’s local high (depicted in the previous figure) is one of the corrections of the price downtrend. The oscillator helps us pick up the moments when the price reverses in the direction of the corrections’ primary trend.

Notes on the strategy:

• You need additional indicators to confirm signals.
• If the second top (bottom) is farther than the first, you enter a trade when the signal level is broken out.
• Signal levels are 30 and 70. You should not change the values.
• Change the chart scale to identify the local trend relative to the global direction.

Cardwell’s trend confirmations

Andrew Cardwell suggested an rsi trading strategy, different from the approach defined by Wilder. For example, instead of the normal signal levels 30 and 70, he offered to consider the values of 40 and 80 for an uptrend, 20 and 60 for a downtrend separately. He claims that a strong uptrend won’t retrace to the RSI overbought zone, as well as a strong downtrend won’t reach the RSI oversold zone. So, the indicator line should be moving between levels 40 and 60, which serve as support and resistance levels. Cardwell’s trend confirmation is when the price rebounds from these levels.

Trading in the bullish and bearish trend:

• In a bullish trend, the indicator line is most of the time between levels 40 and 80. Level 40 is a strong support level. When the price moves up from level 40, it is the right time to open a long position.
• In a bearish trend, the indicator line is most of the time between levels 20 and 60. Level 60 is a strong resistance level. When the price rebounds down from level 60, it is the right time to enter a short trade.

As you see from the above figure, the trend is up. The indicator line is most of the time between levels 40 and 80. Both signals at the moment of touching level 40 are strong and true. Note that you should not consider the price rebound from level 80 as a signal to enter a trade in the uptrend.

The market situation displayed in the above screenshot is not that clear. The trend is down, but the price rebounded from level 65 in the second case.

Notes on the strategy:

• In the bullish trend, you’d better trade in the timeframe starting from M30 and longer with a period of not less than 14. If the period is 9, the indicator often falls to level 30 and turns down from the median level of 50. If you reduce the period, there will be more than 50% of false signals.
• You shouldn’t stick to only the levels suggested by Cardwell. He gave a general idea, and you should adjust it to each particular timeframe and currency pair.

Positive & Negative Reversals

Positive and negative reversals is another trading approach offered by Cardwell. He noted that the rule of direct divergence is not often observed. For example, a positive reversal occurs when the next low is higher than the low of the previous price correction down in the uptrend.

Simultaneously, the next low of the RSI forms lower than the low of the previous correction. Despite the divergence between the price and the oscillator movements, the price continues running up after a small decline. This situation is called inverse divergence.

For the negative reversal, the situation is the opposite. If the indicator forms a higher high, and the price makes a lower high, the market will continue declining.

Trading the opposite direction:

• If the price goes up, and the oscillator line runs down, the price will jump up.

• If the price goes down, and the oscillator line moves up, the price will fall.

In the above figure, red lines indicate that the bearish divergence occurs which is based on the highs. Green lines mark Cardwell’s positive reversal levels. The divergence drawn across the highs should have signaled a bearish divergence and a soon price reversal down. However, the price continued rising.

Notes on the strategy:

• Cardwell’s ideas are different from the trading theory suggested by Wilder. This proves that there are universal rules in technical analysis.

RSI Stock Screener

It is related to the stock RSI indicator meaning. The oscillator is used not only to analyze the Forex market and the forex trading signals. One can also employ stocks Relative Strength Index in the stock market to spot separate securities for short-term investments.

There are thousands of equities traded in the global stock market. One of the ways to select stock for investment is the stock screener. 

The stock screener is an analytical platform that provides information on securities. The advantage of screeners is that they offer dozens of filters to sort and group the shares based on any parameter. A screener could be both a website and a part of an analytical information portal.

Read a detailed overview of screeners here. 

What does RSI indicator mean in the stock market? One of the filter parameters is the data of technical indicators, for example, the RSI stock indicator. Investors should find securities that are currently overbought or oversold and carry out a deeper analysis. You will know if it will be profitable to buy or sell a particular paper.

Examples of screeners:

1. Investing. It is an analytical portal that has a built-in screener.

• In the main menu, enter the tabs Instruments — Stock Screener.
• In the window that opens, custom the information parameters: country, exchanges, sector, and so on.
• In the criteria window, select Technical analysis, and click on the needed tool (RSI). Set the RSI values for the overbought zone.

There are amazon shares in the below list. I open the LiteFinance trading terminal:

Everything is correct. Thanks to the screener, I didn't have to revise all the charts of the securities. You can also filter shares by other indicators and criteria.

The disadvantage of Investing is that you can select securities only by the RS index with a period of 14 in the 1D timeframe.

2. Finviz is another financial analytical portal. It offers more filter parameters. However, the screener analyzes only the US stock market.

Example of successful RSI trading strategy

Using RSI indicator in Forex market trading. As an example, I will take the EURZAR currency pair in the M5 timeframe. I want to demonstrate to you how to enter a profitable trade, rather than make the maximum profit.

Analyzing the above chart, I see the following:

• The downtrend has broken out the strong resistance level. Zooming in the chart, we see that the price hasn’t fallen so deep for more than ten days.
• The Relative Strength Index with a period of 14 and signal levels of 30 and 70 suits to trade this pair.
• There starts forming a W-shaped failure swing pattern.

The price is likely to reverse soon, considering several signals. The resistance level is broken out, the indicator line enters the overbought zone, and there is a forming failure swing pattern. We expect the trend reversal and enter a trade when the indicator line breaks out level 30 from below.

Now, the matter is when we should close the position. We could have waited until the index goes up to level 50. We could have also presumed that there is the beginning of the new strong uptrend. 

According to Cardwell’s RSI meaning in stocks, the price rise could be a local correction within the ongoing downtrend. So, I do not risk and exit the trade at the first sign of the trend reversal.

I am correct. The trend, following the local correction, has resumed running down. Furthermore, I made a profit on the local correction (marked with the arrow in the screenshot).

RSI trading has yielded a small profit in a short time. This is an example of a scalping strategy.

You can combine the RS oscillator not only with the trend, channel indicators, or graphical analysis but with other oscillators as well. For example, there is the rsi trading strategy Triple confirmation. 

It is based on the combination of the RSI, CCI, and stochastic. One enters a trade when the signals of all three technical analysis tools coincide. Signals are rare, but the accuracy is more than 80%.

Summary of the RSI Forex trading strategies

I will sum up in a few paragraphs:

1. Relative Strength Index is a leading momentum indicator. RSI measures the trend strength. It is used to confirm entry signals. It was created by Wilder and first published in his book, New Concepts in Technical Trading Systems.

2. The index value changes in the range from 0 to 100. The default signal levels are 30 and 70. The price range between levels 30 and 0 is the oversold zone. The range between 70 and 100 is considered overbought RSI zone.

3. The indicator works in any timeframe. The default period is 14. For minute timeframes, you can set a period of 5, 7, 9. For the daily chart timeframe, the period is 25.

4. The significant signals delivered by the RS index.

• The reversal in the overbought market zone and crossing the level from above is a signal to enter a short position. The reversal in the RSI oversold zone and crossing level 30 from below signals a long entry.
• Divergence. The indicator line and the price chart go in opposite directions. It signals a soon trend reversal.

5. The values of the signal levels adjusted to each currency pair and timeframe. The settings are:

• Levels 40 and 80 are for a bullish trend. Levels 20 and 60 are for a bearish trend.
• 5% rule. You set such a level on the daily timeframe, above/below which the indicator line has been no longer than 5% of the time for the last three months.

6.  You exit trades according to the market situation. You close the position in the following cases: 

• When the indicator line abruptly reverses in the range between 30 and 70.
• When the indicator reaches the median level 50 (conservative strategy).
• When level 50 is reached, you close half of the position. The rest of the position is protected by the stop at the breakeven and is closed when the oscillator reaches the opposite signal level (aggressive trading).
• There appears a reversal pattern.
• The market price reaches the take profit level.

You can read a detailed overview of how to use your personal profile here. I’d like to remind you that you still can take part in the LiteFinance Dream Draw. Register with LiteFinance, enter trades, be confident in yourself, and you will succeed. If you still have questions, write them in the comments and I will be glad to answer!

I wish you successful trading!

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The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteFinance. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.

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