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In today’s episode, you’ll discover how you can use the RSI indicator to improve your trading results.
So tune in right now…
Resources
A Complete Guide to Stochastic Indicator
The Complete Guide to MACD Indicator
Trend Following Trading Strategy Guide
Transcript
Hey, hey, what’s up my friend? In today’s episode, I want to talk about the RSI indicator and how you can use them to improve your trading results.
(This will be kind of like an RSI indicator “cheat sheet”.)
What is the RSI indicator
RSI stands for Relative Strength Index, a momentum indicator developed by J. Welles Wilder.
The values of the RSI indicator oscillate between 0 and 100. You can never go below zero and you can never go above 100.
Since it’s a momentum indicator, it measures how fast the price moves. The faster the price has increased, the greater the RSI value. The faster the price has dropped, the lower the RSI value. If the price moves up or down very slowly, the RSI indicator will be in the middle, around the 50, 60 range.
The RSI can fluctuate between 20, 30 and go all the way up to 70, 80 or even over 90 especially when there’s strong momentum in the market.
But what’s significant is the levels between 30 and 70. Because traditionally, when the RSI reaches 30, it’s considered to be oversold and when the RSI indicator crosses above 70, the market is considered to be overbought.
Avoid making this mistake when using the RSI indicator
Here’s the thing, remember I just shared with you that the RSI is a momentum indicator which measures how quickly the price moves.
If the 14-period RSI is below 30, what it’s telling you is that over the last 14 days, the prices have dropped a lot in the market and there’s strong bearish momentum. The market is oversold.
In that sense, yes the market has declined strongly, but it does not mean that the market will make a rebound any time soon. Just because it’s oversold doesn’t mean that the market will go up higher – this is a mistake many traders make.
They think that just because the RSI indicator is oversold, it means it’s time to buy. Or just because the RSI indicator is overbought, it’s time to short.
What the indicator is telling you is that there is strong momentum in the market. If it’s overbought, it’s telling you that there is strong bullish momentum. And if it’s oversold, it’s telling you that there is strong bearish momentum. That’s the key thing.
Just because it’s oversold doesn’t mean it’s time to buy, neither does oversold mean it’s time to short. No, it doesn’t work that way. Don’t make this mistake that I’ve seen many traders make.
How to use the RSI indicator as a trend filter
The RSI indicator as mentioned previously measures momentum. It calculates its average gain relative to average loss.
So what you can do with the RSI indicator is to use it as a trend filter to trade in the direction of the trend. What you can do is to set your RSI settings to 200-period. This setting means that the RSI indicator will look through the last 200 candles to measure the average gains to average loss.
If over the last 200 candles, the average gain is more than the average loss, you can imagine that the RSI indicator will be above 50 because there are more gains than losses. Likewise if over the last 200 candles, the average loss is greater than the average gain, then your RSI indicator will be below 50.
So the RSI indicator can be used as a long term trend filter. The gist of this is if the 200-period RSI indicator is above 50, you can conclude that this market is in a long term uptrend and you can look for buying opportunities.
If the 200-period RSI indicator is below 50, you can conclude that this market is in a long term downtrend and you look for selling opportunities.
Now when I used the word ‘long-term’ it’s relative to the timeframe you’re looking at. Because if you refer to the 200 candles on a 5-minute timeframe, it will be a long term uptrend or downtrend on the 5-minute timeframe.
If you do this on a daily timeframe, it will be a long-term downtrend or uptrend on the daily timeframe.
How to use the RSI indicator to better time your entries
Let’s say the RSI dips below 30 and then it’s slowly starting to cross back above 30. This tells you that over the last few candles, there is buying pressure stepping in and that led the RSI indicator to cross back up above 30.
For those of you who are familiar with bullish reversal candlestick patterns like hammer pattern or engulfing pattern, the RSI indicator can be another entry trigger if you are someone who doesn’t want to use the candlestick patterns.
If you’re bullish on the market and all other conditions are met, and you’re only looking for an entry trigger to get long, you can use the RSI indicator to help you time your entry.
One example could be when the RSI indicator dipped below 30 and then it crossed back above 30. That could be an entry trigger for you to get long.
Take note, this is not a trading strategy itself. It’s only an entry trigger to get into a trade after all the other requirements are met. And that requirement is pretty much determined by your trading plan or strategy.
How to use the RSI indicator to capture a swing
What do I mean by capture swing? Swing trading is a type of trading where you look to buy low, sell high. Imagine that the market is in a range between the support and resistance.
For swing trading, you’ll look to buy near support and sell at the high of resistance, thereby just capturing this one swing or one move in the market. And the RSI indicator can help you capture a swing in the market.
For example, let’s say you got into a long trade based on your trading strategy or a valid trading setup. When do you exit to capture a swing then?
What you can do is to exit when your RSI indicator crosses above 50 because when the RSI indicator crosses above 50, it means that the market has already moved up one move higher.
Since you’re a swing trader and just want to capture one swing in the market, you can exit your trade when the RSI crosses above 50.
These are a few techniques that you can consider when you’re using the RSI indicator. Hopefully, these make sense to you.
And with that said let’s do a quick recap…
Recap
- The RSI indicator is a momentum indicator which measures how fast the price moves
- Don’t make the mistake of buying just because the RSI indicator is overbought or shorting just because it’s oversold
- Improve your winning rate with the RSI indicator by using the 200-period RSI as a trend filter
- Use the RSI indicator as an entry trigger to get you into a trade
- Use the RSI indicator to help you capture a swing in the market – exit when the RSI crosses above 50
With that said, I wish you good luck and good trading. I will talk to you soon.