By Walker England, Forex Trading Instructor
- RSI can be useful in trending and ranging markets
- Traditional signals use overbought and oversold crossovers
- Stops can be managed using a previous low
The Relative Strength Index (RSI) is a poplar oscillating indicator designed to help us determine market momentum and pinpoint entries during a variety of trading conditions. However, depending on if the market is ranging or trending, traders should approach the overbought and oversold RSI values seen below very differently. Today we are going to review the trend developing in gold (XAU/USD), and how RSI can be used to enter into strong moving trends.
Normally traders will use the RSI indicator for what is known as a crossover. A crossover occurs when RSI swings through an overbought or oversold value, then cross back through the selected value. The idea behind this is to enter new trades when momentum returns to the market. This can be a great strategy and normally will work when the market is in a range bound environment used in conjuncture with a support and resistance levels. Ultimately, traders using crossovers are looking to buy when prices are low or sell when prices are relatively high.
However, at the moment this strategy is not conducive for trading strong trends such as gold. Due to the market being in a downtrend, traders should absolutely avoid entering trades when RSI crosses back above oversold values. While traders may be inclined to buy low at these points, the chart below shows in most instances prices continuing toward lower lows. So the question is, how can RSI be helpful in directional markets.
XAU/USD with RSI Crossovers
Using RSI Momentum
When it comes to trending markets, it is important to remember that RSI is a momentum oscillator. Because of this, it is normal for RSI to remain oversold in a downtrend for some time. This can often be disheartening for swing traders as they wait for RSI to move back above oversold values for a chance to sell a RSI crossover in a downtrend. The good news is, this is not the only way to trade using RSI! Let’s look at another way of trading the indicator.
One of the most overlooked ways we can use RSI in trending environment is to sell into oversold values. This style of trading may seem counter intuitive at first, but it is very similar to trading a breakout strategy. As price continues to decline and work to create new lows RSI should move to lower lows as well. Traders watching this momentum can actually institute new trades when RSI moves below 30 (Oversold). The Daily Gold chart below is an excellent example of this technique at work. Instead of buying an oversold crossover, traders will look to sell as soon as RSI becomes oversold.
XAU/USD with Oversold Entry
The key to using RSI in this manner is that markets must remain trending. For gold, this can continue as long as fresh lows are put in place. It is important to remember that market conditions are always subject to change. In the event that the current trend ends, RSI traders can then shift gears and begin using RSI in another format.
As you can see, RSI is a versatile indicator for timing entries in a variety of market conditions. To learn more about RSI and how it can be used in an active trading plan, sign up for the DailyFX RSI training course linked below. Registration is free, and the course will include videos, checkpoint questions and access to an advanced RSI strategy. Get started using the link below.
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—Written by Walker England, Trading Instructor
To contact Walker, email: firstname.lastname@example.org. Follow me on Twitter at @WEnglandFX.