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Overbought and Oversold as they relate to the RSI Indicator

Overbought and Oversold as they relate to the RSI Indicator

Richard Krivo, Trading Instructor

Student's Question:To complete the assignment I came up with a historical EUR/JPY Daily chart with an RSI 14 that dropped below 30 and now I'm waiting for 2 or 3 days until the RSI jumps back over 30 and gives a clear BUY signal.Instructor's Response:Nicely done on this interpretation of the Relative Strength Index...Once the RSI is below 30,it can remain there for quite sometime. It is important to wait, as you rightly mention, for it to come back above 30 to provide an entry signal.

Too many traders interpret the RSI being below 30 and in "oversold" territory to mean that it is time to immediately go long at the moment the oversold reading occurs. What many traders do not realize is that even though a pair is oversold, it can become even more oversold. The RSI can meander around below 30 with the price continuing to drop and thus wreaking havoc on any trader who took a long position as soon as it fell below 30.It is critical to WAIT for it to move back above 30 before taking a long position.Conversely, when the RSI is above 70 and in overbought territory, a trader must wait until the RSI moves below 70 to signal a short entry.When trading this market, patience is definitely a prerequisite.

Also, as with any indicator, the higher probability trades will occur when the indicator signals taking a trade in the direction of the Daily trend.

For those traders who have a live account with FXCM and want to learn more about the RSI, click on the RESEARCH button at the top of your live Trading Station.

On the next page that comes up, click on Trading Course and then scroll down the RSI button and click it for access to four lessons dedicated to the RSI indicator.

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.