Basic RSI Trading System
The Basic RSI Trading System is based on only one indicator.
RSI is also known as Relative Strength Index and it is an oscillator indicator.
Not relying on any other indicator, this system is quite simple.
It can be used on any timeframe and many markets.
The entry rules are as follows:
RSI value must read values below 30 (oversold) and cross the threshold upwards.
Wait for the price to close bullish and RSI to have a value above 30.
Place a buy stop above the high of that confirming candle.
Set a stop loss below the low of the confirming candle or below the latest swing low.
The target can be the previous swing high or a level that fits a risk : reward ratio of 1 : 2.
RSI value must read values above 70 (overbought) and cross the threshold downwards.
Wait for the price to close bearish and RSI to have a value below 70.
Place a sell stop below the low of that confirming candle.
Set stop loss above the high of the confirming candle or the latest swing high.
The target can be the previous swing low or a level that fits a risk : reward ratio of 1 : 2.
What is RSI trading strategy?
An RSI trading strategy is a set of trading rules that use the RSI indicator.
The traders try to assess the market conditions.
They choose the RSI indicator to get assistance in picking the appropriate moment to enter a position.
The profitable trades are usually those resulted from positions taken in tune with the market.
Such a strategy can take into account a number of other indicators to filter out the noise or confirm the main signal given by the RSI indicator.
The RSI indicator oscillates between 0 and 100.
Within that range, traders consider values on top of the range and at the bottom of the range especially important.
The upper part of the range describes a condition of the market known as overbought.
The lower part of the range describes a condition of the market known as oversold.
The overbought threshold is usually above 70.
The oversold threshold is usually below 30.
Even though these are the most used values, nothing says traders cannot use other values in order to widen or make the trading zone narrower.
Some traders use 20 and 80 as the threshold values, while others use 40 and 60.
Depending on the trading system, timeframe, market conditions and a number of other factors, the oscillator can be used to indicate what we need to know about the market we choose to get involved in.
Testing different values on different timeframes, market conditions, and even different markets may offer more insight into which are the appropriate values to use.
What is a good RSI number?
The RSI indicator derives its value from the past price values.
The longer the reference period, the smoother the curve the oscillator draws.
With that smoothness, also comes the drawback of delayed signals, though.
In order to pick a good RSI number, traders have to test which values fit best the timeframe and the market they intend to trade.
Even though the RSI has a default value of 14 periods, that is not necessarily the best number for any timeframe or any market.
The traders that wish to have more signals may pick a smaller number, like 10.
Conversely, those that are more risk averse, may want to choose a bigger value, like 20 or even more.
Some markets trade only between certain hours of any given day, while other markets trade 24 hours a day 5 days a week.
On top of that, not all markets are equally active during trading hours, or even in all days of the week.
To make things even more complicated, traders should consider the timeframes they trade and fit that into the bigger picture.
For example, the RSI calculated over a period of 10 on the 5 MIN timeframe is practically plotting less than one hour of price evolution in that particular market. On the other hand, the RIS calculated over a period of 10 on the 60 MIN timeframe will be plotting the price oscillations over a period of about a half of a day, which spans and spills over the entire trading period of any major market opened during that particular trading day.
That’s why traders should consider enough factors when choosing their indicators values so that their trading system will fit not only the timeframe of their choice but also the market conditions they intend to trade in.
How do I trade RSI divergence?
RSI divergence is a type of condition many traders choose to include in their analysis and use in their trading activities.
The premise is quite simple.
The price includes the most relevant information available (undelayed).
Any oscillator includes less relevant information (delayed).
Between the highs and lows of the price and the oscillator’s readings may appear some divergences.
Simply put, the price may plot higher highs while the oscillator does not, or the price may plot lower lows, while the oscillator does not.
These occurrences may signal a shift in momentum in that particular market.
In turn, a shift in momentum may indicate an exhaustion of the energy that manifested in that market recently.
Divergence trading aims at anticipating and timing ample market moves such as corrections or reversals.
In and of themselves, divergences are not a strong enough signal for most of the traders that use them.
Usually they are included in trading systems and the signals are filtered using a number of other indicators in an attempt to generate more robust signals.