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Friday, May 08, 2009

Range Trading With The RSI Indicator

For most of the time, currency pairs in the Forex market are trending by moving sideways, or trending up or down, within a certain price channel. For trading in such a market, use the scalping technique with the RSI indicator. These short trades, often only a few hours in duration, keep the pips coming while you wait for a bigger move.

The Relative Strength Index (RSI) is a popular oscillator. It’s a lagging indicator, measuring the past momentum of a currency pair’s price by comparing upward price pressure (green candles.

If you use candlestick charts against the downward price pressure (red candles) over a defined period of time. This is usually 14 days, the default setting in most software packages, but experiment to see what works best for you.

Like most oscillators, RSI is displayed as a squiggly line within a window beneath the chart itself. It varies up and down on a scale of 1 to 100, like a percentage, so it’s easy to understand.

The Technique

The RSI is excellent for range-bound markets. When the RSI climbs above the 70 line, that indicates the currency pair is overbought and that the people who purchased should be ready to sell it, thereby lowering the price; when it drops below 30, it’s been oversold. When the RSI crosses back over that point a second time, that’s the signal to enter the market.

For example, let’s say the GBP/USD is range-bound and dropping toward its support level. Below the chart, the RSI indicator follows it down and drops below 30. That warns you the currency pair has been oversold, and that people should be ready to purchase it, which means the increased buying pressure will cause the price to rise.

If you purchased the GBP/USD at that point, because other traders watching the RSI might not yet have caught on, the price might still be falling. You could be stopped out, losing pips.

But when the RSI changes direction and rises back above the 30, that’s the time to enter the market long. Place your stop below the price support level so that market jitters won’t trigger it accidentally, then sit back and count the pips as the price climbs back to its resistance point.

When the price reaches that point, close your trade. Then watch the RSI to see if it climbs above 70, when you can reverse the procedure.

This sort of range trading is a form of scalping. It doesn’t earn many pips at a time. But they add up, and if the signals are strong enough to justify the risk, you could always purchase more than one lot, compounding your pips as if they were interest.

Another way of reading the RSI is called divergence. That’s when the price on the chart reaches a new high or low, but the RSI doesn’t follow suit. It can be a powerful tool, too, because usually the price will change direction to follow the RSI rather than the other way around, and you can scalp more pips when the price moves to catch up.

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1 comment:

James Denham said...

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