RelativeStrengthIndex

YourStep-by-StepGuideto

ProfitableTradingwiththeRSIIndicator

TableOfContentsIntroductionChapter1–WhatIsRelativeStrengthIndex?

Chapter2–HowDoesRSIWork?

–Example#1

–Example#2

–AdditionalThingstoUnderstandaboutRSI

Chapter3–MeanRevisionTrading

–ExactRSITradingSignals

–AReal-WorldRSIExample

Chapter4–TrendTrading

–HowtoUseRSIforTrendTradingStep-by-Step

Chapter5–Tips,Techniques

andCommonPitfalls

Chapter6–FinalNotes

Conclusion

IntroductionIwanttothankyouverymuchandcongratulateyoufordownloadingthebook,RelativeStrengthIndex–YourStep-by-StepGuidetoProfitableTradingwiththeRSIIndicator.ThisbookistheultimateguidetoprofitabletradingwithRelativeStrengthIndex.

Inthisbook,you’lllearnwhatRSIisandhowit’scalculated,you’lllearnhowtouseRSItogenerateexacttradingsignals,you’lllearnstep-by-stephowtouseRSIfortrendtradingandmeanrevisiontrading,andyou’llbewalkedthroughmultiplecompletereal-worldexamples.Thanksagainfordownloadingthisbook,I

hopeyouenjoyit!

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Chapter1–WhatIsRelativeStrengthIndex?Whentryingtodeterminetheright time to buy or sell afinancialinstrumentsuchasastock or currency pair, it isimportant that you try topredictfuturemovement.Oneofthemostimportantaspects

of this is understandingmomentum – how stronglythe instrument is moving upor down. While strongmovement in a particulardirection can show a likelytrend,itcanalsoindicatethatthe instrument is overboughtoroversold.RSI is one of the keyindicators that technicaltraders use to measuremomentum. RSI stands for

‘RelativeStrengthIndex’andis represented as avalue thatranges between 0 and 100.Values above 50 indicateupwards momentum, whilevalues below 50 mean thatthemomentumisdownwards.The larger the distance from50, the stronger themomentum.Valuesabove70or below 30 indicate thatmomentum is so strong thatthe market is overbought oroversold.

Chapter2–HowDoesRSIWork?RSI measures how often themarket closes up versusclosing down – and by howmuch.Itiscalculatedusingarelatively simple formulashownbelow:RSI=100-100/(1+RS)

As can be seen from theformula, this will alwaysyieldanumberbetween0and100, provided that RS is apositive number. However,whatexactlyisRS?Thatisalittlemorecomplicated.Itistheaveragesizeofalloftheupmovesover the lastNperiods divided by theaverage size of all of thedownmovesoverthesameNperiods. The best way of

understanding this is bylookingataworkedexample.AssumethatyouaregoingtomeasureRSforastockover9days,usingthecloseeachdayas the input to the formula.Herearetheclosingpricesforthose nine days, plus onemore day at the start sinceyou will need to knowwhether the price has closedup or down in any particularday.

2.10,2.20,2.30,2.25,2.27,2.23,2.28,2.31,2.3,2.24

Thiscanbeused tocalculatehowmuchthepriceclosedupor down in any given day asshownbelow:0.10, 0.10, -0.05, 0.02,-0.04, 0.05, 0.03, -0.01,-0.06

This can then be used to

calculatehowmuchthepricefinished up each day,assumingthatifthepricefellin a particular day, then theamount that it rose was 0.Thisgivesthefollowing:0.10,0.10,0.00,0.02,0.00,0.05,0.03,0.00,0.00

Similarly, the equivalent sizeof the price falls over thesamenine-dayperiodwere:0.00,0.00,0.05,0.02,0.04,

0.00,0.00,0.01,0.06

Note that in this case we’reonly looking for themagnitude of the price drop,not the direction, andtherefore all the values arepositive.If we take a simple movingaverageoftheupmovementsand another SMA of thedownmovements,weendupwithtwonumbers:

AvgU = sum (0.10, 0.10,0.00,0.02,0.00,0.05,0.03,0.00,0.00)/9=0.32/9=0.03555555AvgD = sum (0.00, 0.00,0.05,0.02,0.04,0.00,0.00,0.01,0.06)/9=0.18/9=0.02000000

DividingAvgUbyAvgDgivesusRS,whichinthiscaseis1.77.PluggingthisintotheRSIformulaweget:

RSI=100–100/(1+1.77)=63.89

Therefore, in this case, themarket has strong positivemomentum but it does notappearthatitisoverboughtatthispoint.Itisalsoworthnotingthatthedifference between the totalup moves and total downmovesis0.32-0.18,or0.14,

which is exactly what isexpected since the price rose0.14 in total during theperiod. However, RSI is notsimply an indicator of howmuchthepriceroseorfell intotal. For instance, considerthe following two alternatescenarios,bothofwhich leadtoa0.14totalriseinprice.

Example#1

Thepricerosefor8daysoutof9,withatotalriseof0.15.Itonlyfellfor1day,andthenonlyby0.01.ThisgivesanAvgUof0.16666666andanAvgDof0.01111111.TheRSis0.16666666/0.01111111or15.TheRSIistherefore100–100/(1+15)or93.75.Inthiscase,RSIisindicating

thatthemarketisveryheavilyoverbought,eventhoughtheoverallpricerisewasstillonly0.14.Thismakessense,sincetherehasbeenanalmostinexorablepriceriseoverthelastninedayswithnorealsignsofresistanceorpullback.

Example#2

Thepricerosefor4daysoutof9,withatotalriseof0.81.Thepricefellfor5daysoutof9,withatotalfallof0.67.Inthiscase,AvgUis0.09000000,andAvgDis0.07444444.However,RSisnow1.21andtheRSIis54.73.Thereisverylittleupwardmomentum,despite

thetotalpricerisestillbeing0.14overthe9dayperiod.Again,thismakesintuitivesense,sincetherehasbeenahugeamountofvolatilityandatotalriseof0.14becomesrelativelyinsignificantcomparedtothelargedailypriceswings.From these two examples, itbecomes clear that RSI doesprovide a strong indicator ofmarket momentum that is

only loosely coupled to thetotalpricemovement.

AdditionalThingstoUnderstandaboutRSI

ThereareseveralotherthingstounderstandaboutRSI:• First,ifthepriceriseseverydayduringtheperiod,then AvgD becomes 0. Inthiscase,dividingAvgUby

AvgDleadstoanundefinedresult(divisionby0).Inthiscase, RSI is defined to be100.• Second, while theeasiest and most commonmethod of calculating RSIinvolves taking simplemoving averages, somevariants use exponentialmoving averages. There isalso a special averagingapproach called Wilder’s

Smoothing Method that issimilar to an exponentialmoving average but uses adifferent smoothing factor.This was invented by thecreator of theRSI indicatorandisnamedafterhim.•Third,RSIsarenotjustcalculated over 9-dayperiods. They can inprinciple be calculated overanyperiod–forinstance,anRSI calculated over 9 days

is referred to as RSI 9,whereasonecalculatedover14daysisreferredtoasRSI14.Ingeneral,thelongertheperiod, themore slowly theindicator responds tochanges in price directionand momentum. RSI 14 isthemostcommonlook-backperiodand is thedefault onmosttradingworkstations.

Chapter 3 – MeanRevisionTrading

Asmentioned earlier, one ofthe things thatRSI can showis that the market isoverbought or oversold –rememberthat70oraboveisoverbought, while 30 orbelowisoversold.Infact,thiswas theoriginal intentof theindicator and is the basis of

meanrevisiontrading.In mean revision trading,tradersarelookingforapricereversalbecausethemarketisoverbought or oversold. Bydefinition, thisisacontrarianstrategy – the trader is goingagainst the prevailing pricetrend.Atitsmostbasic,therearetwotradingsignals.

Exact RSI TradingSignals•IfRSIisbelow30,thenwait for it to rise above 30and then buy. Don’t buy itwhen it is below 30, sincethemarketcanstayoversoldfor an extended period oftime with the pricecontinuing to fall.Once the

indicatorrisesabove30,thismayindicatethatthesellingpressure is starting to ease,andthatthepricemaybesettorise.• Similarly,iftheRSIisabove70,thenwaitforittofallbelow70andthentakeashort position. In this case,thedipinRSIindicatesthatbuying pressure may bestartingtoease.When used in this way, RSI

worksabout75%of the time– whenever there is a pricereversal. However, theamount that the price movesishighlyvariable andcanbeinsignificant in many cases.Because of this, it isextremely important tomanage risk carefully whentaking positions based onthese signals. If stopsarenotcarefully placed or toomuchleverage is used, then largetrading losses can occur. As

withanyposition,ifthepricestartstomoveinthedirectionyou were hoping for, use atrailing stop to lock in yourprofits.

A Real-World RSIExampleHere is a real-worldRSI sellsignalexample.

Chapter 4 – TrendTradingWhile RSI is often used todetect overbought andoversoldconditionsand tradeagainstthecurrenttrend,itisworthwhile remembering thatit is an indicator of strength.Because of this, traders alsouse it to trade with trends.

Themaindifferencewiththisapproach is that differenttrigger points are typicallyused to signal buying andsellingopportunities.Specifically, thereisnopointin using 70 and 30, since asalready discussed, these leadto price reversals in about75%ofcases.Instead,weakertrigger points are used, withthemostcommononesbeing60 and 40. At these points,

there is strong marketmomentum but themarket isnot overbought or oversold.60isusedasatriggerpointtotakea longposition,whereas40 is used as a trigger fortakingashortposition.This is completely theopposite strategy to meanreversion trading. Considerthecasewherethereisstrongupwards momentum. Withmean revision trading, 70 is

used as the signal to take ashort position, whereas 60 isused as the signal for a longpositionwithtrendtrading.As with mean reversiontrading, however, it is stillimportanttoputaproperriskmanagement strategy inplace.Theriskislower,sinceyou are trading with thetrend, but there is still apossibilityofapricereversal.

How to Use RSI forTrend Trading Step-by-StepThefollowingisashortstep-by-stepguidetousingRSIfortrend trading. In this case, itlooksatthecasewhereRSIisindicating upwards marketmomentum.

1. WaituntiladayclosesandtheRSIisabove60.2. Takealongpositionatthestartofthenextday.3.Putastoplossinplace.Agoodplacetodothisisatthelowpricefor thelast10days.4. Continue to trail thestop lossat the10day low,adjustingiteachday.5. Ifyouare stoppedout

subsequently, take yourprofitsorlossesatthispoint.6. If theRSI falls below40, thenuse thisasasignaltoexityourposition.Infact,iftheRSIdoesfallbelow40,youmaywanttotakeashortposition.Thisistheothertradingsignal.Theprocesshereisexactlythereverseofthestepsgivenabove–takeashortposition,placeyourtrailingstopsatthe

10dayhighandexitmanuallyifRSIgoesabove60.

Chapter5–Tips,TechniquesandCommonPitfallsAsmentionedpreviously,itisextremelyimportanttohaveaproper risk managementstrategy when you are usingRSI as a trading signal. Thisisparticularly thecase ifyouare using RSI for mean

reversion trading, since youare trading against a trend. Itisnotunusual forRSIvaluestoriseabove70andthenfallback several times in quicksuccession, and the sameapplies when it dips below30. If this happens, you willprobably end up with anumber of small tradinglosses if you have a properrisk management strategy inplace.Ifyoudon’t,youcouldend up losing a significant

proportionofyourcapital.Second,whileRSIisawidelyusedindicator,itisnotoneofthe most accurate ones,particularly if it is used formean reversion trading. It isbestemployed inconjunctionwithother indicators thatcanbe used to confirm signals.For instance, if RSI risesabove 30 or falls below 70,these signals are madestronger if they are

accompanied by highvolumes or an increasingvolumetrend.To reiterate, another thing toremember if you are usingRSI for mean reversiontrading is to avoid selling iftheRSIisabove70andavoidbuyingiftheRSIisbelow30.While these may clearlyindicate that the market isoverbought or oversold, RSIcanremainatthesevaluesfor

extended periods of time. Ifyou buy in at this point, yourun the risk of taking aposition contrary to a trendthat will continue for weeksor even months. Again, thiscan lead tosignificant losses.It is only when the indicatorreversesandgoesbelow70orabove30thatyoushouldusethisasasignal.Similarly, if your strategy isto follow a trend, don’t exit

your position just becauseRSI goes above 70 or below30.Forexample,ifyoutakealongpositionwhenRSI risesabove 60, there is no reasonto sell when it hits 70. Themarket may be overbought,buttheupwardtrendmaystillcontinue for a significantperiod of time. If you exit atthispoint,youwillbeleavingmoney on the table. Ofcourse, you need to followyour position with trailing

stops as discussed previouslyso that you do not end upgiving back all your profits,but this is the approach youshouldtakewithanystrategythatfollowstrends.Finally,aswithanystrategy,youshouldnotblindlyfollowarecipeandassumethatitisgoingtowork.Firstofall,thereisnosuchthingasaguaranteedstrategyandusingRSIisnoexception.Second,

whileRSI14isthemostcommonlyusedindicator,youmaywanttoexperimentwithotherRSIperiodstoseeiftheygiveyoubetterresults.Infact,thismaydependtosomeextentontheparticularmarketsthatyouaretradingin–sodosomeresearchtoseewhetherornotdifferentRSIvalueshaveworkedforothertraders.Ofcourse,whenyoudoexperiment,it’sagoodideatodothisby

analyzinghistoricalchartsorusingademoaccountifyouaretradingintheforexmarket.Don’tputyourcapitalonthelineifyouhavenoideawhetheraparticularstrategyislikelytosucceed.

Chapter6–FinalNotes

Trading using RSI is arelatively straightforwardapproach, and is fairly wellsuited to traders with a widerange of experience andabilities. There are twomainstrategies – mean reversionand trend trading, with trendtrading being the less risky

option.However,theRSIindicatorisnot the most dependableindicator, particularly formean reversion trading. It isoftenbestusedinconjunctionwith other indicators thatcreateaconfluenceofsignals.As a minimum, you need tomake sure that you have arobust risk managementstrategy in place and thensticktoit.

Anotheradvantageseenbyrangetradersisthatwhenoperatingalongonlyrangetradingstrategytheywillnothaveapositionandbe‘outofthemarket’forlongperiodsoftime.Thismeansthattradingcapitalisavailabletobekeptondepositorusedforothertradingopportunities.

Conclusion

Thankyouagainfordownloadingthisbook!YoushouldnowhavetheknowledgeyouneedtogetstartedtradingwithRSI.Thenextstepistotakeaction!Finally,ifyouenjoyedthis

book,pleasetakethetimetoshareyourthoughtsandpostareviewonAmazon.It’dbegreatlyappreciated!Thankyouandgoodluck!

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