The 70/30 RSI trading strategy is a well-liked method that makes decisions about purchasing or disposing of different financial instruments, like stocks or currencies, using the RSI (Relative Strength Index) indicator. The RSI provides insights into overbought and oversold market conditions, providing traders with a valuable tool for timing their trades. In this article, we’ll explore how RSI is used in forex trading as well as how it works.
The 70/30 RSI trading strategy has two threshold levels
The RSI indicator was developed by a technical analyst named J. Welles Wilder to help traders evaluate the strength of the current market. It is most commonly used to identify overbought and oversold conditions in the market. The RSI, which has a range from 0 to 100, is commonly used to identify overbought or oversold conditions in a market. The 70/30 RSI strategy involves setting two threshold levels on the RSI indicator: 70 for overbought conditions and 30 for oversold conditions. These levels are used by traders to generate buy or sell signals. Readings of 30 or less usually indicate an oversold market and an increase in the possibility of price strengthening (rising).
Some traders interpret that an oversold currency pair indicates that the falling trend is likely to reverse, which means it presents an opportunity to buy. Readings of 70 or higher indicate overbought conditions and an increase in the possibility of price weakening (falling). Some traders interpret that an overbought currency pair is a signal that the rising trend is likely to reverse, which means it’s an opportunity to sell.
What is the Relative Strength Index (RSI)?
The relative strength index (RSI) is a momentum indicator used in technical analysis. RSI measures the speed and magnitude of recent price changes in securities, providing insights into whether the price is overvalued or undervalued. Displayed as an oscillator in a line graph on a scale of zero to 100. As well as pointing to overbought and oversold securities, the RSI can also indicate potential trend reversals or corrective pullbacks in a security’s price. It can signal when to buy and sell.
Understanding RSI’s trading strategy
An RSI reading of 70 or above shows an overbought situation. A reading of 30 or less indicates an oversold condition. One of the weaknesses of the RSI is that sudden, sharp price movements can cause it to spike repeatedly up or down, which makes it prone to giving false signals.
However, those spikes or falls, when compared with other signals, could signal an entry or exit point. It is not uncommon for the price to continue to extend well beyond the initial RSI signal, where it indicated the market as being overbought or oversold. For this reason, a trading strategy using RSI works best in combination with other technical indicators to avoid entering a trade too early.
How the RSI trading strategy works
As a momentum indicator, the RSI compares the strength of a security on days when prices rise to its strength on days when prices fall. Relating the result of this comparison to price action can give traders an idea of how a security may perform. When used in combination with other technical indicators, the RSI can help traders make better-informed trading decisions.
To calculate the RSI, you must first determine a time frame: one week, two weeks, etc. From there, you have to add up all the average gains and divide the value by the total of the average losses. This value is the RSI.
Overbought or oversold
In general, when the RSI indicator crosses 30 on the RSI chart, it is a bullish sign, and when it crosses 70, it indicates a bearish sign. Simply put, an RSI value of 70 or above indicates that a security is becoming overbought or overvalued. It may be ready for a trend reversal or corrective price pullback. On the other hand, an RSI reading of 30 or less indicates an oversold or undervalued condition.
The term “overbought” describes a security that trades at a price level above its true (or intrinsic) value. That means that it’s priced higher than it should be, according to technical or fundamental analysts. Traders who observe that a security is overbought may expect a price correction or trend reversal. Therefore, they may sell the security.
The same principle applies to a security highlighted as oversold by technical indicators such as the relative strength index. It might be perceived as trading at a lower price than it should. Traders monitoring such an indication might expect a price correction or trend reversal and buy the security.
What is a good RSI index?
A specifically “good” RSI index does not exist. RSI values are indicators that help traders make decisions depending on their goals. RSI values below 30 usually indicate buy signals, whereas values above 70 generate sell signals.
What is a better indicator than RSI?
Various indicators provide different insights. RSI sheds light on overbought or oversold assets. It is not very helpful in identifying trends. The moving average convergence divergence (MACD) indicator is more effective for that.
Why is the RSI important?
RSI is a useful tool for traders to predict how the price of a security will move. There are several key aspects:
Predicting price behavior: Traders can use RSI to predict the price behaviour of a security.
Validating trends: It can help traders validate trends and identify possible trend reversals in the market.
Overbought and oversold signals: They can indicate overbought and oversold securities, helping traders make informed decisions.
Providing buy and sell signals: It can provide short-term traders with buy and sell signals, helping in timely decision-making.
Technical indicator for trading strategies: It’s a technical indicator that can be used in combination with other indicators to develop and execute trading strategies.
Limitations of RSI’s trading strategy
The RSI compares bullish and bearish price momentum and presents the results in an oscillator placed below a price chart. As with many technical indicators, its signals are most reliable when they align with the long-term trend.
True reversal signals are infrequent and can be difficult to distinguish from false alarms. For example, a false positive occurs when a bullish crossover is followed by a sudden decline in a stock. A false negative would occur when there is a bearish crossover but the stock suddenly accelerates upward.
Since the indicator displays momentum, it can remain overbought or oversold for a long time when an asset has significant momentum in one direction. Therefore, the RSI is most effective in an oscillating market (a trading range) where the asset price alternates between bullish and bearish movements.
Should you buy when the RSI is low?
When the RSI reading goes below 30, some traders interpret this as a buy signal. This is based on the idea that the security has been oversold and is expected to rise in value. However, how reliable this signal is depends, in part, on the overall context. If the security is caught in a strong downtrend, then it might continue trading at an oversold level for a considerable amount of time. In that situation, traders might hold off buying until they see other technical indicators confirm their buy signal.
In summary
The RSI helps traders gauge whether a market is overbought or oversold so that they can expect either momentum or a pullback in prices. When the RSI is set up and read correctly, along with other indicators, it can help technical traders determine their trading strategies, such as entry and exit points, buying or holding, or shorting positions. RSI can be used in various markets, including stocks and forex.
Disclaimer:
This information is not considered investment advice or an investment recommendation, but instead a marketing communication. IronFX is not responsible for any data or information provided by third parties referenced or hyperlinked in this communication.
Sign up to our newsletter
Please note that your email will be solely used for marketing purposes. For further information, please read our Privacy Policy
