The RSI or Relative Strength Index shows how strong a price is by comparing downward and upward close-to-close movements. The indicator was developed J.W. Wilder and was included in his classic book “New Concepts in Technical Trading” which was printed back in Seventies and the indicator has remained popular ever since. Let’s look at the RSI in more detail and how you can include it in your currency trading strategy for bigger profits.

Relative Strength Index (RSI) Defined

The RSI a momentum oscillator which is used to show overbought or oversold levels in the financial instrument being studied. The RSI compares the upward price movement to downward price movement over the specified timeframe and is the ratio of exponential moving averages  of the upward (U) and downward (D) price movements, normalized into a value between 0 and 100.

Relative Strength Index (RSI) The Calculation

The Calculation is as  follows:

 U = Pn - Pn-1
 D = Pn - Pn-1
 EMAUP = EMAUn-1 + ((2 / (n + 1)) * (Un - EMAUn-1))
 EMADOWN = EMADn-1 + ((2 / (n + 1)) * (Dn - EMADn-1))

RSI therefore = 100 X (EMAUP / (EMAUP + EMADOWN))

In terms of time frame any can be used but Welles Wilder recommends using a smoothing period of 14, by his calculation of EMA smoothing i.e. α=1/14 or N=27.

Don’t worry if you don’t understand the above calculation, you don’t need too – all the major currency chart services will show it visually, so you can see at a glance how the indicator is shaping up.

Using the RSI

The RSI is normally used in two different ways:

The RSI can be used to identify an overbought level when it is above 70, and an oversold level when it is below 30 – although many traders like to use a slightly more extreme reading in currencies of 80 / 20.

The RSI can also be used as a divergence indicator, based upon divergence between the RSI and the price of the currency and this is typically done from overbought or oversold levels. If for example the RSI turns down from overbought levels and the price is still rising, a sell trading signal can be considered and the reverse, scenario would occur in a bear market.

Final Words

Wells Wilder is one of those traders whose indicators have stood the test of time, in the book “New Concepts in Technical Trading” he not only introduced the Relative strength Index, he also outlined the Average Directional Movement Index and the Parabolic Time indicator and ALL these indicators remain popular today over a quarter of a century later and the reason why is they help time trading signals with greater accuracy.

If you are looking for an essential FX trading indicator you should make part of your essential FX trading education – look no further than the RSI. This indicator, is simple to use and can help your currency trading strategy, time trading signals better so you can make bigger profits and that’s what all traders want so - learn about the Relative Strength Index today.