How to Trade RSI in Forex
The Relative Strength Index is a momentum indicator that forex traders should learn how to use.It is used to measure the price of the currency being traded relative to itself over a fixed period of time.It is normally 14 bars on a scale of 0 to 100.It shows the forex trader the ratio between the number of periods that closed up and those that closed down.
In forex trading, most trading platforms have the look back period at 9 periods though you can use various periods that you can choose. The shorter the period, the more volatile is the indicator thus producing more forex trading signals. The longer the forex trading period, the more stable the RSI is and produces less trading signals.
The RSI is used to measure when the forex market is overbought, oversold or has the momentum or keep on moving in the same direction. The normal levels indicating that the market is overbought is when the RSI moves above 75. To indicate the forex market is oversold, the RSI moves below level 25.
Some forex systems do allow the changing of either the look back period or the overbought or oversold levels. Some forex systems also use the RSI as a trend indicator and would depend on the RSI being either below or above the 50 level.
In the example forex chart below, you can see that the RSI of 9 periods in the usdchf chart rose above level 75 at point A. Soon the market lost it’s momentum and the usdchf started falling.
At point B, the market was oversold and below level 25 soon the usdchf started rising again.
When the market is gathering steam, and approaches or crosses the 75 and or the 25 levels, there is a strong likely hood that the forex currency one is trading would regain or retrace some of it’s previous move.As a good forex trader, one should always understand that a strong likely hood is not the same as a definite occurrence.
Note that at point B, the first time the RSI(9) falls below the 25 line, the market did not stop it’s downward move or trend. That is the main reason why most forex systems are a number of forex trading indicators working together to either confirm or disprove a trading decision.
You always have to be alert as a forex trader as even though the RSI shows either an overbought or oversold condition,the market could just be gaining more steam to continue in the same direction.Many new forex traders misuse the RSI and try to catch market tops or market bottoms using just the RSI. A good forex trader should be aware that buying or selling in anticipation of an indicator is a bad forex trading habit.
For those developing trading forex trading indicators, the RSI is calculated as
RSI =100 – (100/1 + RS)
RS -Average of x periods up closes / average of x period down closes.
x is the look back period which you as the trader can choose.
Drawbacks of Online Forex Trading
Online forex trading has become one of the fastest growing industries mainly due to the ease of online forex trading. Due to the fact that traders have reduced commissions, speed of forex execution, flexibility in forex trading and detailed forex trading information, forex trading has been growing exponentially for the past 6 years.It is easy to see that the lure of making a living online trading forex is not going to end.
It is not all a bed of roses however. Forex trading has it’s challenges and many a forex trader have lost their fortunes. It is assumed that only less than 10% of forex traders actually make a living trading forex.
There is a difference between traditional stock and futures trading and forex trading.The most obvious is that forex trading is done almost exclusively online. It is attractive for those who wish to make money online but it can have drawbacks compared to traditional broker assisted trading.
Some of the drawbacks of online forex trading vs traditional futures and stock brokers are :-
1.Forex Beginners Need Guidance
Unlike stock and futures trading, most forex trading is done online. A forex trader normally does not have the luxury of a traditional broker who would be explaining how to make orders etc.
Most forex traders tend to learn how to trade the forex market through trial and error and joining forex forums. There is no formal market so even forex beginners have to teach themselves how to trade the forex market.
2. Placing Forex Trading Orders
Other than teaching yourself how to trade, there is an issue with how to place forex trading orders. Every broker has their own forex trading platform. It is highly advisable to learn how to place forex orders in each forex trading platform you would be using.
There are traders who have had the experience of placing buy orders instead of sell orders and have had their trading capital lost.A traditional broker would probably make sure that the right orders are placed.
3. Lack of Forex Risk Control
Most good traditional brokers will alert a trader when he is running into trouble with their trading capital. Online forex trading platforms do not. A forex trader runs the risk of exhausting his capital since there is no one to warn him of bad trading decisions.
4. Danger of Forex Overtrading
A forex trader sitting behind his computer can be easily mesmerized by the real time forex quotes, ticking news systems, beautiful trading graphs and without supervision might fancy themselves to be professional forex traders.
Overtrading is easy to do . Most forex traders mistake online trading for an open invitation to trade non-stop. Some forex systems are actually sold that promote trading every minute. It normally leads to new forex traders losing their trading accounts.
Though there are drawbacks to online forex trading, it is still becoming more popular as nothing is more attractive as an opportunity to make money online trading forex in the comfort of your own home.
