The Most Popular Forex Indicator

The Relative Strength Index (RSI) is a momentum oscillator that measures the speed and change of price movements. Developed by J. Welles Wilder Jr. in 1978, the RSI helps traders identify overbought and oversold conditions in the market, making it a vital tool for spotting potential turning points.

The RSI is displayed as a line graph on a scale of 0 to 100. A value of 70 or above typically indicates that a currency pair is becoming overbought, meaning it may be overvalued and due for a price pullback or reversal. Conversely, a value of 30 or below signals that the currency is oversold, potentially undervalued, and could see a price increase.

The platform used in this chart is Trading View. You can open your chart then click on Indicators and then search for RSI in order to easily implement the most popular forex indicator on your chart

The RSI provides clear, easy-to-read signals that can help you understand where the market is heading. Let’s break down its two main use cases: identifying overbought/oversold conditions and divergences.

1. Overbought and Oversold Levels

• RSI Above 70 (Overbought): When the RSI is above 70, it suggests that the currency pair may be overbought. Traders often see this as a sign that the market could be due for a correction or reversal. For example, if EUR/USD has been rallying and the RSI hits 75, it might be a good idea to prepare for a potential price drop or consolidation.
• RSI Below 30 (Oversold): On the other hand, if the RSI drops below 30, the market may be oversold. This could mean the currency is undervalued, and a price reversal to the upside is possible. For instance, if USD/JPY has been falling and the RSI reaches 25, a reversal could be on the horizon.

2. RSI Divergence

Another powerful way to use the RSI is through divergence. Divergence occurs when the price of the currency pair is moving in the opposite direction of the RSI. This can indicate that the current trend is weakening, potentially leading to a reversal.

• Bullish Divergence: This occurs when the price makes lower lows, but the RSI forms higher lows. It suggests that downward momentum is slowing, and the price may soon reverse to the upside.
• Bearish Divergence: This happens when the price makes higher highs, but the RSI makes lower highs. It signals that upward momentum is weakening, and a downside reversal may be imminent.

The RSI is versatile and can be used in various ways to suit different trading strategies. Here are a few popular methods that traders use when applying the RSI:

1. RSI as a Confirmation Tool

Traders often use the RSI to confirm other signals from price patterns, support and resistance levels, or other indicators. For example, if you spot a head and shoulders pattern indicating a potential trend reversal and the RSI is also overbought, that might be a stronger confirmation to enter a trade.

2. RSI and Support/Resistance Levels

Combine the RSI with key support and resistance levels for a more robust trading strategy. If the price reaches a major resistance level and the RSI is over 70 (overbought), this could signal a stronger case for a reversal.

3. RSI and Trend Lines

RSI can also be used in combination with trend lines. Drawing trend lines directly on the RSI can give you another layer of analysis, as the breakout of these RSI trend lines often corresponds with price trend reversals.

4. RSI Swing Rejections

A lesser-known but highly effective strategy is the RSI swing rejection. This occurs when the RSI initially moves above 70 (or below 30), then drops back below 70 (or rises above 30), and finally makes a second move in the same direction (but doesn’t reach extreme levels again). This second swing can be a great opportunity to enter a trade.

Pros:

• Easy to interpret: RSI’s clear numerical scale (0-100) makes it a straightforward tool for traders of all experience levels.
• Versatile: RSI can be used in many different market conditions—ranging markets, trending markets, and during corrections.
• Divergence signals: RSI divergence is an advanced yet reliable way to anticipate price reversals.

Cons:

• False signals in strong trends: In strong trending markets, the RSI can remain in overbought or oversold territory for extended periods without a price reversal, leading to false signals.
• Better in conjunction with other indicators: The RSI should ideally be used in combination with other technical tools like moving averages or trend lines to improve the accuracy of trade decisions.