Relative strengh index (RSI) is an oscillating indicator developed by J. Welles Wilder, it has the function of measuring changes in price momentum. If you know how to use it, RIS can be a very effective leading indicator.

Basically, traders can use RSI to:
  • Identify the main trend;
  • Identify overbought/oversold areas;
  • Or is the recognition of diverging signals.
1. RSI and trend lines

If you notice it can be seen that the RSI line moves very close to the price, even if placed in the same chart, it can cause confusion between the price and the RIS.

For this reason, many traders take advantage to identify trend lines based on the RIS line. Normally, the trendline of the RSI has the same direction as the price trendline, unless a divergence occurs.

The RSI trendline is often broken before the price trendline is broken. And we will use this feature to predict early price reversals.

In the illustration, we have two upward trendlines, one for the RSI, the other for the price. When the price was still very far from the trendline, the RSI reversed and penetrated the RSI trendline.

When the RSI returns to the retest of the trendline, it is also time for the price to peak and starts a reversal phase, turning to a downtrend.

2. Threshold-breaking pattern

Studying the patterns is quite interesting when analyzing charts because the variations of the offerings are so many, and how to apply them in transactions is also very diverse. Any pattern can be a continuation or reversal pattern, making a breakout at some point in time.

With the RSI, not only can we use trend lines, but we can also use patterns to predict the direction of price early.

From this illustration, closely we can realize that the Shoulder - Head - Shoulder pattern has been formed, the neckline has been broken. At the same time, on the price chart, there appeared a double top pattern.

These signals support an assertion that price is likely to reverse and you should consider a sell order.

The above are the first two RSI roles that you can take advantage of, isn't it interesting? In the next part, 3 more advanced applications of RSI, including:
  • Breakout/breakdown pattern advanced
  • The role of the centerline; and
  • The failure swing