If you are looking for reversal trades to either get into an existing trend or the start of a new trend on a currency pair, the RSI reversal strategy can help. This forex strategy looks for extreme overbought or oversold market conditions so that you can time your entry and exit. It is very simple to use but does require some thought on behalf of the user in terms of filtering trades and money management. I will take a look at how to trade RSI reversals in combination with other chart analysis to form a more complete trading strategy.
What is the RSI?
The Relative Strength Index (RSI) indicator is free to use on most forex platforms and shows you when the market has reached extreme buy or sell conditions. Eventually the market must turn around, otherwise it would exist. This is where the RSI indicator comes in handy. It uses overbought levels of 70 and oversold levels of 30. The idea is to look for RSI reversals to the upside when the RSI is below 30 and RSI reversals to the downside when the RSI is above 70.
How to trade the RSI reversal strategy?
When trading RSI reversals, we are looking for RSI extremes on currency pairs and combining them with RSI divergence and other indicators to confirm entry into the market. Yes, you could blindly take all of the RSI signals as they are, but I think that it is important to filter signals to try and reduce the number of false signals you will get.
Buy signal
- RSI (14) is below the 30 level
- RSI is showing bullish divergence
- Price is above 14-period SMA
- Bullish candlestick patterns
- Stop loss above recent resistance (optional)
In the EUR/USD 1-hour chart below, you will see that the RSI reversal occurred in the oversold area below 30. There is also strong RSI divergence and price has moved above the default 14-period moving average. We can see support is holding up nicely and there are lots of bullish candlestick patterns including inverted hammer candlesticks. Stop loss could have been placed just below recent support which is around 30 pips. This trade has gone on to make over 500 pips so far which shows the power of the RSI reversal strategy when combined with other forms of market analysis and sensible money management.
Sell signal
- RSI (14) is above the 70 level
- RSI is showing bearish divergence
- Price is below 14-period SMA
- Bearish candlestick patterns
- Stop loss below recent support (optional)
You can see from the EUR/USD 1-hour chart below that the price had crossed the 14-period moving average and there was a bearish RSI reversal signal along with divergence to the downside. There is a large engulfing bar and price is moving away from recent resistance. This all suggested a sell trade which went on to reach around 350 pips. We could have had a stop loss just above the moving average which would have been around 20 pips, giving a very good risk to reward ratio on this position.
RSI reversal strategy Pros & Cons
Pros
- Can be used in trending and ranging markets
- Can be used on any currency pair and timeframe
- Can be combined with any other indicator
- RSI indicator is free and easy to use
- Customise RSI settings according to your style
Cons
- Requires good timing on entry and exit
- Needs sensible money management
- Lots of false signals if not filtered
Conclusion: is the RSI reversal strategy any good?
Yes, I think the RSI reversal strategy is a simple yet effective way to enter buy and sell trades on currency pairs. It can be used for timing your entry into an already established trend and for trading reversals in range bound markets. However, I think it works best when used alongside other technical analysis and price action analysis including candlestick patterns. Not to mention, any forex strategy is only as good as the user who is implementing it.
You will need to ensure that you have good money management and trading discipline. I have seen the same forex strategies give completely different results due to the way they were being implemented. For instance, if a forex trader was using a 1:3 risk to reward ratio, they could have a win rate below 50% and still come out on top. On the other hand, a trader who was using a wide stop loss and tight take profit, could see one bad trade wipe out a consecutive run of winners.
If you want to give the RSI reversal strategy a try, you could start on a forex demo account. This can be a good way to practice your trading strategies and master your skills before making a financial commitment. You can get a free forex account from most brokers including IC Markets. They have very good trading conditions from my experience, with low spreads and competitive commission fees.
Yes, I think the RSI reversal strategy is a simple yet effective way to enter buy and sell trades on currency pairs. It can be used for timing your entry into an already established trend and for trading reversals in range bound markets. However, I think it works best when used alongside other technical analysis and price action analysis including candlestick patterns. Not to mention, any forex strategy is only as good as the user who is implementing it.
You will need to ensure that you have good money management and trading discipline. I have seen the same forex strategies give completely different results due to the way they were being implemented. For instance, if a forex trader was using a 1:3 risk to reward ratio, they could have a win rate below 50% and still come out on top. On the other hand, a trader who was using a wide stop loss and tight take profit, could see one bad trade wipe out a consecutive run of winners.
If you want to give the RSI reversal strategy a try, you could start on a forex demo account. This can be a good way to practice your trading strategies and master your skills before making a financial commitment. You can get a free forex account from most brokers including IC Markets. They have very good trading conditions from my experience, with low spreads and competitive commission fees.
Self-confessed Forex Geek spending my days researching and testing everything forex related. I have many years of experience in the forex industry having reviewed thousands of forex robots, brokers, strategies, courses and more. I share my knowledge with you for free to help you learn more about the crazy world of forex trading! Read more about me.
