How RSI is Calculated

The formula for RSI may look complex, but it’s built on simple averages.

1. Calculate the average gain over a specific period (usually 14 periods).
2. Calculate the average loss over the same period.
3. Divide the average gain by the average loss to get the Relative Strength (RS).
4. Apply the formula:

RSI = 100 – [100 ÷ (1 + RS)]

For example, if during the last 14 periods the average gain was 1.2% and the average loss was 0.6%, RS = 1.2 ÷ 0.6 = 2.
Plugging this into the formula:

RSI = 100 – [100 ÷ (1 + 2)]
RSI = 100 – [100 ÷ 3]
RSI = 100 – 33.33 = 66.67

This means RSI is showing momentum close to overbought levels.

Why RSI Matters in Forex Trading

Unlike some technical indicators that are hard to interpret, RSI is simple and effective. It helps traders answer three crucial questions:

1. Is the market trending strongly or losing steam?
   RSI helps identify if momentum is fading.
2. Is a reversal coming?
   When RSI is extremely high or low, it may signal that a trend is about to change.
3. Where are the best entry and exit points?
   Traders can use RSI to decide when to buy or sell, avoiding emotional trading.

For Forex traders, who often deal with fast-moving markets and tight margins, this clarity is invaluable.

Standard RSI Levels: 70 and 30

The classic interpretation uses the levels of 70 and 30:

• Above 70: Market could be overbought → Possible sell signal.
• Below 30: Market could be oversold → Possible buy signal.

However, in trending markets, RSI may stay overbought or oversold for a long time. That’s why experienced traders adjust these levels or combine RSI with other indicators.

Advanced RSI Settings: 80/20 and 60/40

Some traders prefer alternative thresholds:

• 80/20: Gives fewer but stronger signals (useful in volatile pairs like GBP/JPY).
• 60/40: Helps capture trends earlier and reduces false signals (often used in long-term trading).

By adjusting RSI levels, you can tailor it to fit your personal trading style.

RSI Divergence

Divergence occurs when the price and RSI move in opposite directions. This is one of the most powerful signals RSI can provide.

• Bullish Divergence: Price makes lower lows, but RSI makes higher lows. This suggests the downtrend is weakening, and a reversal could follow.
• Bearish Divergence: Price makes higher highs, but RSI makes lower highs. This suggests the uptrend is losing strength.

Example: If EUR/USD keeps climbing but RSI fails to confirm the new highs, it could be a warning that buyers are exhausted.

RSI Trading Strategies

Here are some of the most effective ways traders use RSI:

1. Overbought and Oversold Strategy

• Buy when RSI drops below 30 and crosses back up.
• Sell when RSI rises above 70 and crosses back down.

This is the simplest method but works best in range-bound markets.

2. RSI Divergence Strategy

• Look for bullish or bearish divergence between price and RSI.
• Combine with candlestick patterns (like Doji or Engulfing) for stronger confirmation.

3. Trend Confirmation with RSI

• In strong uptrends, RSI often stays above 40.
• In strong downtrends, RSI often stays below 60.
• Traders use this to confirm trend direction and avoid counter-trend trades.

4. RSI + Moving Average Combo

• Combine RSI with a Moving Average (MA).
• Example: Enter a buy trade when RSI crosses above 30 while the price is above the 50-period MA.

This helps filter false signals and adds confluence.