The Relative Strength Index (RSI) is one of the most powerful indicators you can use in both your forex scalping strategy and your normal trading strategy especially if you’re interested in technical analysis, however, the tricky thing is using it correctly. Most people do not know how to use RSI properly and miss out a lot on its potential.
Today we will reveal the secret RSI trading strategies that the trading desks’ of the largest hedge funds and banks use. We guarantee you that at the end of this article, you will never see the RSI indicator in the same light ever again.
RSI Indicator Explained
In short, the Relative Strength Index (RSI) is an oscillator that fluctuates between 0 and 100 with the main goal of identifying overbought and oversold areas in the market. Standard levels are below 30 for oversold (meaning price is going to bounce up soon) and above 70 for overbought (meaning price is going to reverse down soon). Now, this is what about 99% of the market use the RSI indicator for.
What if I told you that it can also be used in many different ways?
When used correctly, an RSI indicator can help you identify the following :
- Hidden support and resistance levels (horizontal)
- Hidden support and resistance levels (diagonal)
- Hidden breakout levels
- Bearish divergence reversals
- Bullish divergence bounces
In this article, we’ll cover all of this and see how they can combine really well with forex scalping strategy to provide you with a truly fantastic trading strategy.
Best RSI Period
Before we get started on the RSI trading strategies, a common question I get asked is what the best RSI period is for scalping, intraday trading, etc. Well, I’m here to finally put this long standing debate and dilemma to rest.
The best RSI period to use are actually a bunch of periods to switch between. I recommend using 21, 34 and 55 as your periods. However, you have to use them smartly with the methods below to fully utilize their hidden power. In the examples below, you will notice I switch between 21 and 34 quite often in finding the optimum setups and finding hidden trading opportunities.
RSI Trading Strategy Explained (Video)
RSI Trading Strategy : Hidden Support & Resistance Levels (Horizontal lines)
A large problem people face when using the RSI indicator is knowing when a reversal is going to occur. We have seen it all too often when RSI reaches the industry’s 30/70 levels and you expect a reversal, only for price to continue moving and stopping you out. This can be very frustrating and is one of the main reasons people stop using the RSI after awhile.
However, an industry secret is that the 30/70 levels are simply there to trick the retail traders. The real resistance levels found through manually plotting levels and seeing how they correspond to price. We will now run through a couple of examples to see how this is done.
EURAUD Example :
We can see RSI is not responding to the standard 70% resistance, instead, it it reacting better against 52% resistance. You can also see how price is dropping every time RSI reaches the 52% level, this is a good indication of a hidden relationship between RSI and price. Many normal traders at this point are waiting for RSI to reach the 70% level before they play the drop, but not us, as we’re able to see the hidden truth.
From the above picture, we can see perfectly how price has dropped and along with it, RSI too. This is the perfect example of how we have to look for hidden patterns and signals within the RSI. A normal trader who uses 70% as their resistance on RSI would never have guessed that the market was going to react at the 52% level.
EURJPY Example :
We can see that the resistance level to watch out for on RSI is 65%. Every time RSI reaches 65%, price tends to see a reaction. So form here, we can establish that there is a hidden relationship between RSI and price. A normal trader at this stage is thinking : Oh my, price has broke out of the channel, time to buy and go long!
However, we’re smarter than that. We know that even though price has made a bullish exit of the descending channel, we are still seeing major resistance at the 65% level on RSI. This is clearly one more of those clever traps the market is setting for normal traders. Because of this, we choose to sell while the rest of the world is choosing to buy.
Guess who came out on top? Us! Because we are able to see the hidden truths and relationships with RSI that many retail traders are not able to. This is once again a brilliant example of how we can use hidden horizontal support and resistance lines on RSI to our advantage.
So what does this teach us?
This teaches us that the best setting to use for RSI is not the 70/30 levels that the industry tells us, instead, we have to be smart and look how each market responds differently to different levels of RSI and from there, we can uncover hidden resistance levels (and support levels) to look out for.
So whenever you use RSI to analyze a chart, do this :
- Look at levels where prices bounce off or react from
- Look at corresponding RSI levels and see where they bounce/react from
- See if you can connect a horizontal line across them. If you can, you have found a good hidden resistance/support level on the RSI. It doesn’t have to be an exact percentage, it can even be a small area (eg. 52% to 54%)
- As a best practice, it is usually better to find at least 3 corresponding points where price and RSI behaved in tandem.
RSI Trading Strategy : Hidden Support & Resistance Levels (Diagonal lines)
So now that you have let your mind adjust to the paradigm shift of accepting hidden RSI horizontal levels as support and resistance, let me take you one step further and try to accept that support and resistance can come in the form of diagonal lines.
“What?! Is that even possible?” Yes it very much is.
The trick is to look for ascending support line and descending resistance lines on your RSI indicator.
USDJPY Example :
Here is an example of an ascending support line on the RSI indicator. We can see that price has bounced off this ascending RSI support line multiples times in the past. Based on this, we should be able to see price bounce once more time upwards. The next picture will show you how price followed the bounce on RSI as expected.
Now, that trade worked out brilliantly didn’t it? Most people would not be able to see the hidden relationship between RSI and price in this instance because it looks like it is bouncing off random levels. However, a trick is to see whether diagonal lines are able to pick these levels and most of the time they work out wonderfully.
So what does this teach us?
This is a brilliant example of using an ascending support line on RSI to determine where the next bounce is going to occur along with price.
A few best practices to take note of when using this method :
- The more number of ‘bounces’ you can get on the RSI, the better. In the above example, there are 2 bounces which is the bare minimum before one can expect a bounce on the third time.
- This strategy works even better when price is also right on a support level corresponding with RSI’s ascending support. This can be in the form of a forex scalping strategy or a horizontal forex scalping strategy.
- The strategy works even better when there is a bullish divergence of RSI vs price (when you’re expecting a bounce) or bearish divergence of RSI vs price (when you’re expecting a drop).
RSI Trading Strategy : Hidden Breakout Levels
Sometimes when price is bouncing off a support level, we are unsure whether it is a real bounce or a fake bounce. Usually there is downside pressure and we’re afraid of ‘catching a falling knife’ so to speak. However, there is a very great technique to figure out whether we’re really going to see a bounce through using RSI. The trick is to see whether RSI has made a ‘breakout’ of its pattern. An example is below.
USDJPY Example :
We can see that RSI has made a bullish breakout of a descending resistance-turned-support line which goes in line with price making a bounce above the 101.30 level which has been trading sideways for a few days. This gives us confidence of it making a rise from here.
The picture above shows how price has made a bounce as expected. Along with that, we see another bullish exit on RSI that stretches further back. This gives us confirmation that we’re seeing a much bigger rise on price.
The picture above shows how price rose up as expected and reached our profit target :)
So what does this teach us?
When we see price continuously moving in one direction and we can’t tell whether it’s going to bounce of drop, one of the key methods we can use is to see if RSI does a bullish or bearish breakout as a pre-signal that price is going to bounce. Often they tell the hidden story that we can’t see when just looking at price.
A few best practices to improve the success rate of this RSI trading technique :
- If you can see price making a similar bullish or bearish breakout along with RSI making its bullish or bearish breakout, it greatly increases the success rate of the breakout. This can happen in many forms (breakout of triangle, wedge, channel, support, resistance, etc.)
- If you’re seeing a long move down or up, if the breakout level on RSI corresponds with a 23% Fibonacci retracement in price, it works even better. This is because the 23% Fibonacci retracement is usually a confirmation of a larger move.
- If there was bullish divergence vs price on RSI before the bullish breakout, or bearish divergence vs price on RSI before the bearish breakout, this is a good sign of price indeed moving in the direction we expect.
RSI Divergence Indicator Strategy
One of the other ways we can tell whether price is going to bounce or drop soon is by seeing if there is recent bullish or bearish divergence against RSI. I would go as far as to say that the RSI divergence indicator is used more as an additional element of confirmation rather than a strong indicator by itself. It is best used in conjunction with the above RSI strategies like horizontal support/resistance, diagonal support/resistance and breakouts. Below is an example of how RSI divergence works well with the horizontal support levels.
AUDNZD Example :
We can see that RSI is right above strong horizontal support at 4% and also displays bullish divergence versus price. This is a good indication of price making a bounce from here. It is also nice to see that price is right on strong support (horizontal support + fibonacci retracement). which gives us further confidence of price making a bounce from here.
We can see that price has made a bounce perfectly from our buying level and reached our profit target perfectly, as predicted by price. Amazing, right?
So what does this teach us?
This teaches us that the RSI divergence indicator can be used more as an additional element of confirmation instead of purely trading off the divergence. Here are some best practices to combine the RSI divergence with to get the best results :
- When RSI is also seeing horizontal support or resistance or diagonal support or resistance
- When price also happens to be above a key level of support (for bullish divergence) or below a key level of resistance (for bearish divergence).
- Bullish divergence needs at least two swing lows on RSI but can extend to multiple swing lows. The only rule is that each swing low on RSI has to be rising (from left to right) and each swing low on price has to be falling (from left to right).
- Bearish divergence needs at least two swing highs on RSI but can extend to multiple swing highs. The only rule is that each swing high on RSI has to be falling (from left to right) and each corresponding swing high on price has to be rising (from left to right).
In conclusion, we have to open our minds when learning how to use RSI as a trading strategy. Try to see beyond what the industry norm is on simply finding support and resistance levels at 30% and 70%. There are many ways that we can also use RSI for forex scalping strategy so be sure to combine these unique techniques with the wide range of strategies we have here.