The RSI indicator is a cruel mistress!
The RSI indicator is usually the go to oscillator for the novice trader when deciding to enter that first trade. There is a simple, valid reason for this: The RSI indicator is simple to read and understandand it “APPEARS” to get great results when given the visual back-test!
The fact is: Oscillator indicators in general, are risky and unreliable beasts.
In general the RSI is interpreted as follows;
If the indicator is below 30, then the price action is considered weak and possibly oversold, the possibility of a DOWNTREND reversal greatly increases
If it is reading above 70, then the asset is after a strong uptrend and could be overbought, the possibility of a reversal of the UPWARD trend greatly increases
Life is never that simple though, and more often than not, you will find that the risk involved in this type of simplistic approach is ruinous to you account balance.
RSI is a leading indicator: signal price tops and bottoms BEFORE they actually occur
Just because the RSI enters into these extreme levels, it DOES NOT mean you necessarily need to Buy or Sell. At a minimum, such movements should ALERT you to the POSSIBILITY that a TREND REVERSAL is imminent
Often the price will continue to rise even after the RSI crosses above 70. And you may carry a loss for an uncertain amount of time if you buy when RSI crosses below 30 and the price continues to fall
LIMIT: RSI is NOT USEFUL in TRENDING market
Here are some quick lessons:
Wait for conformation before considering a trade. The RSI can remain at extreme levels for long periods in a strong trend;
Don't jump right in when you see a reading of 90, first allow the RSI line to fall back below the overbought line to at least give a stoploss level to trade off .
Watch the Centreline for trend confirmtion.
If the RSI line reaches an extreme and then returns to the centreline it is a better indication of a turning point in the trend. Waiting for this to occur can cut out those nasty impulsive trades!
It is common for technical traders to watch the centreline to show shifts in trend,
If the RSI is above 50, then it is considered a bullish uptrend, and if its below 50, then a bearish downtrend is in play.
Here are a few techniques that you can use to cut out a lot of false signals:
Compound RSI Strategies:
There are a few indicators that pair well with the RSI and using them together can proved better trading signals.
Only enter the market whenever the RSI gives an overbought or oversold signal which is supported by the a bullish or bearish engulfing candle.
Enter the market whenever the RSI gives an overbought or oversold signal which is supported by a MACD signal line crossing.
Close the position if either indicator provides an exit signal.
RSI, MA Cross
Place a trade when the RSI gives an overbought or oversold signal which is supported by a crossover of the moving averages.
Close the position on an RSI divergence.
RSI, Bollinger band
Wait for a Bollinger band squeeze
Enter the market whenever the RSI gives an overbought or oversold failure swing.which is supported by a tag of the bands in the same direction.
Close the position on an RSI divergence.
The Laguerre RSI Indicator is a modification of the well-known relative strength indicator or RSI.John F. Ehlers, the famous trader who created the Laguerre RSI, tried to avoid whipsaws (noise) and lag produced by smoothing technical indicators by applying a filter and some changes to the original relative strength indicator.The result is a technical indicator that is more responsive and has much less noise than the original RSI indicator.
How to trade the Laguerre RSI:
Buy when the Laguerre RSI crosses above 0.15 (upwards)
Sell and Short when the Laguerre RSI crosses below 0.85 (downwards)
The uptrend is considered strong if the Laguerre RSI stays flat above the 0.85 level.
The downtrend is considered strong if the Laguerre RSI stays flat below the 0.15 level.
DeMark's Range Expansion Index (REI)
One limitation of the RSI indicator is that if price moves up or down the RSI will fluctuate even if price movement is not very meaningful. DeMark’s REI is an attempt to reduce the influence of price movements that are little more than “noise”. Rather than just noting the change in price from close to close each day, REI compares the high or low of certain days to the high or lower of certain other previous days to update the indicator value each day.
The TD REI is a market-timing oscillator which highlights risk areas for buying and selling.
Overbought Levels - Readings of +45 or higher indicates overbought conditions.
Oversold Levels - Readings of -45 or lower indicates oversold conditions.
The indicator has a buy zone, a sell zone and a neutral zone. Negative readings within an uptrend signal potential buying opportunities, positive readings within a downtrend signal potential shorting opportunities.