The RSI is one of the most popular forex indicators for technical analysis. It can do a good job of spotting overbought and oversold currency pairs. It is traditionally used for reversal trading but can also be used to trade breakouts. When the RSI reaches a value over 70, traders consider the indicator overbought. Conversely, a reading under 30 is considered oversold. This is a basic RSI reversal strategy that you can combine with support and resistance levels to trade breakouts in extreme market conditions. This additional confirmation can give you an edge on your trades and help to filter out false signals.
How to trade the RSI breakout strategy?
We will first look for a typical RSI crossover to the extreme buy (below 30) or extreme sell (above 70) levels. We will then want to look for strong support or resistance on the chart which we will watch for price to break through. Keep an eye on price action around the time of entry to check for any candlestick patterns that can give extra confirmation for entry and exits.
- RSI (14) is above the extreme 70 level
- RSI divergence to the upside
- Price breaches recent resistance
- Bullish candlestick patterns
You can see from the GBP/USD 15-minute chart below that the RSI indicator was in the extreme overbought zone and there is RSI divergence to the upside. Price broke through the resistance level and we can see quite a few chart formations confirming the trade including three white soldiers and doji candlestick patterns. Price is also above the 14-period moving average for good measure. We could have placed the stop loss just below the 14 SMA which would have been around 20 pips. That is not bad when you consider the currency pair went up over 200 pips.
- RSI (14) is below the extreme 30 level
- RSI divergence to the downside
- Price breaches recent support
- Bearish candlestick patterns
Looking at the GBP/USD 15-minute chart below you will see that all of the conditions have been met for an RSI breakout trade to the downside. Price is below the 14 SMA, the RSI is extremely oversold and showing bearish divergence. There are multiple candlestick patterns suggesting downwards momentum including three black crows and the hanging man formation. Price broke through the support level with a big red bar that started a good down trend. If we placed the stop loss on the other side of the 14 MA, it would have been around 30 pips. This gives a good risk to reward ratio when you consider the down trend lasted for over 200 pips.
RSI breakout strategy Pros & Cons
- Catch some good market reversals
- Get in on trends from the beginning
- Can be used on any currency pair
- Can be used on any timeframe
- Can combine with any other technical indicator
- Requires timing the entry and exit
- Will be false signals even when filtering
- Support and resistance are not always reliable
- Needs sensible money management and discipline
Conclusion: is the RSI breakout a good forex strategy?
Yes, trading the RSI breakout can be a successful strategy but there is much more to it than blindly taking every buy and sell signal. You will need to filter them to try and remove the false signals which can occur with any forex strategy. Not to mention, the success of any trader can depend significantly on money management and discipline.
The RSI breakout strategy can give a completely different set of results depending on the stop loss and take profit levels that a trader is using. Of course, the win rate will also have a great impact on results as will emotions such as fear, anger and greed.
For instance, a trader with a 50 pip stop loss and 10 pip take profit, could see 5 winning trades wiped out by one losing trade. That is without considering broker fees. On the other hand, a trader with a 10 pip stop loss and 50 pip take profit, could have 4 losing trades and still make pips with just 1 winning trade.
If you want to try out the RSI breakout forex strategy, you could always start on a demo account. You can get a free forex demo account from most forex brokers. This will allow you to master your trading skills without any risk. Once you build up enough confidence and see some consistent results, you may then consider switching to a live account.
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