RSI Trading Strategies |
Professional interpretation of oscillator signals with unique screens
The RSI (Relative Strength Index) indicator is a standard MT4 indicator that belongs to the category of oscillators. It compares the averaged values of rising and falling candles for the period specified in the settings. The formula for calculating it is given in this review. It is also given on many other resources, only it is far from the truth. In theory, provided there are no falling candles, the denominator of the fraction is “0” and the RSI is equal to 100%. But if you set period 2 on the last three growing candles, the indicator will show 90% at best.
The theory differs from practice in the field of indicator signal interpretation. In some places, the ideas of the RSI author Wilder radically diverge from those of his follower Cardwell. They are both partly right, but this only proves once again that there are no uniform rules for using indicators in technical analysis. Read more about the options for trading RSI strategies.
Interpreting RSI Signals
RSI moves between 0 and 100. By default, signal levels are 30 and 70, but no one forbids changing them. Option – setting the levels by the principle of pulling them up following the indicator extremes according to the “5% rule”. If the oscillator line often reaches 80 and immediately reverses, it makes sense to raise the level from 70 to 75.
The screenshot shows that the level 70 is too low. However, raising it will reduce the number of signals.
- Overbought and oversold trading
Classic strategy. If the indicator is in one of these zones, then it will reverse soon. We expect a reversal and open a deal at the moment of crossing the signal levels. If the RSI and trend directions do not match, the signal is ignored.
There are plenty of false signals. In this case, the second was effective. Nevertheless, this interpretation is the most common, and if there are many false signals on the chart, you need to choose a timeframe or period.
- “Failed swing”
An attempt to explain why the indicator does not break through the signal level in accordance with the previous strategy, but returns to it again. Graphical analysis can be applied not only to the price chart, but also to oscillators. And the rebound is the formation of a W or M-shaped pattern on the RSI.
The logic of the pattern is a false reversal, which is a local correction against the background of an ongoing main trend. Therefore, it is also called the swing pattern (or swing strategy). On the screen, you can see a long downtrend and the appearance of an M-shaped pattern on the RSI at the time of correction. The deal is opened at the moment of the second crossing of the 70th level from top to bottom. Please note that you only need to catch such a pattern on a clear trend. To do this, use the graph scaling change (“gray plus”, “gray minus”).
- Divergence (trading strategy RSI by Wilder)
Divergence – the oscillator and the price move in opposite directions. The theory says that the oscillator is ahead of the price, so the price will reverse after it. Construction rules:
- Bullish divergence is based on lows.
- Bearish divergence is based on the highs.
This is an example of a bearish divergence. The oscillator is in the overbought zone, the highs are decreasing. Meanwhile, the price goes up, after which a bearish trend begins. Divergence is considered a strong signal. But you need to be able to see it at the same time on a local and general scale. Therefore, we recommend looking for it on a small scale without approaching the site.
- Reverse divergence (trading strategy RSI by Cardwell)
Wilder and Cardwell were divided on divergence. If Wilder was a supporter of classical divergence, then Cardwell suggested interpreting it in almost the completely opposite way. In his understanding:
- If the price goes down, the indicator is up, then the price will continue to move down.
- If the price goes up, the indicator goes down, then the price will continue to move up.
The key difference is in the construction of reverse divergence lines. It is mirrored.
Bearish divergence is plotted by the red lines at the highs. In accordance with the previous strategy of RSI trading according to Wilder, the price should go down. A reverse bullish divergence is plotted by green lines at the minimums (!) – the price continued to move up.
How to explain the almost cardinally different interpretation of the signals of both technical analysis gurus, you will not find in any source. Therefore, it is easier to agree that both options have the right to life. And the trader’s task is to have time to determine which template path the price has followed. By Wilder’s or Cardwell’s template.
- Trading the bullish and bearish trend (trading strategy RSI by Cardwell)
Another innovation of Cardwell, which changes the classic worldview regarding signal levels 30/70. He suggests setting 40/80 levels on a bullish trend, and 20/60 on a bearish one. The logic is simple: if the trend is growing, it is more likely to hit the highs of the overbought zone. This means that the levels should be shifted for the accuracy of the signals. This has a negative effect on the number of signals, but their quality increases. We open deals at the moment of rebound from levels (80th or 20th). In other words, we are not talking about the breakout of the signal level at the reversal (according to Wilder), but about the rebound of the RSI from the channel border.
The screenshot shows that a rebound occurs from level 40 on an uptrend. At these moments we open deals. An important point: on an uptrend, a rebound from the 80th level is not a signal (blue arrows). If the RSI goes below the 40th level on an uptrend, then it makes sense to consider opening a trade on a reversal. But you need to be careful with the stop loss.
- Trading on resistance and support levels
This RSI trading strategy is based on finding coincidences of local price extremes and their coincidence with horizontal resistance and support levels. The essence is classic: when the extremums coincide and when the levels rebound, a deal is opened. The values of the signal resistance and support levels are not important in this case.
The two price lows coincide with the RSI touch of the 30th level. The diagonal price level shows the moment of the bearish trend breakout. The breakout coincides with the breakdown of the 30th level oscillator – open a sell trade.
Strategy options based on combined indicator versions:
Conclusion… The above RSI trading strategies show the possibilities of using the indicator. It is impossible to create a trading system based on it alone – be sure to add patterns, graphical analysis, and other indicators. Be flexible – learn to see all the possible options, choose the one that is most likely.