Posted by forex at 6:50 AM
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1. Create a price chart of any financial product. You can use stocks, futures, foreign currency exchange or bonds. Any trading platform and many online charting services provide the features for charting prices (See Resources).
2. Add the 'RSI' study. This is one of the most common technical indicators and most charting services offer this tool.
3. Study the past RSI action in the sub-graph that appears below the main price chart. Notice how it 'oscillates' between 0 and 100. The RSI typically rises when prices rise, and falls when prices fall.
4. Compare subsequent highs in real price action with the corresponding subsequent highs in the RSI. If prices make a new high but the RSI makes a lower high, this is called 'divergence' and is one of the most common observations using oscillator tools. A divergence often indicates an imminent reversal in prices, since the new high price occurs on weaker relative strength.
5. Identify how prices typically move after the RSI reaches extreme levels. While traders vary in their interpretations of RSI extremes, many consider a move above 80 or below 20 to be an 'overbought' or 'oversold' condition, respectively. Prices often bounce higher after the RSI is oversold and decline, if temporarily, after the RSI is overbought.
6. Change the parameters of the RSI study to see different ways to analyze relative strength. Most charting programs allow you to alter the default settings. A two-period RSI is a common setting that may provide more interesting information.
7. Exit trades based on RSI information. While many traders use the RSI to identify potential trade entry signals, you can also use it for insight on when to exit, or sell, a stock position. One strategy is to sell your position if the 2-period RSI closes above 70. This suggests that the market may decline after this point, causing your position to also decline in value.