RSI Trend Strategy

The RSI is a very popular forex indicator which can be used to identify the trend of a currency pair and help us to avoid getting in too late. The RSI trend strategy can be used on any forex currency pair and chart timeframe. We are looking to first identify in which direction the market is trending, using the RSI and a moving average. We can then time our entry into the trend and maximise the move with good money management.

Forex trend trading with the RSI

Most forex traders will know the RSI for being a technical indicator that can spot market reversals when the RSI reaches an extreme overbought (above 70) or oversold level (below 30). However, many ignore the fact that you can use it to time your entry into an existing trend or simply as a filter to decide if there is still enough upwards or downwards momentum left to make taking a position worthwhile.

What timeframe should I use the RSI on?

This really depends on your trading style and the time you have to dedicate to trading forex. If you are day trading, then you might consider the 1-hour charts. You could use even smaller chart timeframes such as the 5-minute charts, but I think there is too much market noise which can give lots of false RSI signals.

Generally speaking, I find that the longer the timeframe, the more reliable forex signals can be. Even if you have a day job, you could always use the daily charts which would mean much less time spent chart watching and perhaps even stronger signals.

What RSI settings should I use?

Again, this can depend on your trading strategy. If you are scalping the forex market, you might be looking to lower the RSI from the default 14-period. I actually prefer to use the default settings as I feel this is what most traders will be watching which can improve the accuracy.

If you increase the RSI settings, then there will be less signals and they might be lagging. However, some traders may argue they will be more reliable as they include a larger amount of price data.

How do you confirm market trends using the RSI indictor?

If you think a trend is forming, take a quick look at the RSI indicator and look at whether it is above or below 50 and not overbought or oversold. If you are looking at a possible uptrend, then make sure the RSI is above 50 but ideally below 70. If you are looking at a possible downtrend, then make sure the RSI is below 50 but ideally above 30. This will help us to spot trends that still have some momentum left.

Using an RSI reversal strategy can sometimes spot a trend at the very beginning by entering on an extreme level. For instance, if the RSI was extremely overbought (above 70), we could look for a sell trade when the market turns around. If the RSI was oversold (below 30), then we could consider a buy trade once the market starts to reverse. These entries can sometimes mean catching big moves from the very start when timed well.

Buy signal

  • RSI below overbought level (70)
  • RSI showing upwards divergence
  • MACD histogram crosses signal line upwards
  • MACD showing bullish divergence
  • Price bouncing from support
  • Bullish price action

If you take a look at the 4-hour USD/JPY chart below, you can see that the RSI divergence is to the upside and the MACD crossover along with MACD divergence has also confirmed upwards momentum. We can see price has bounced from a recent significant support level and there are lots of bullish candlestick patterns including specific reversal patterns such as the rising wedge. We could have placed the stop loss just below the recent swing low which would have been around 70 pips. This uptrend continued for almost 2,000 pips, which shows how well the RSI trend strategy can do when timed well and given the right market conditions.

RSI Trend Strategy Buy Signal
RSI Trend Strategy Buy Signal

Sell signal

  • RSI above oversold level (30)
  • RSI showing downwards divergence
  • MACD histogram crosses signal line downwards
  • MACD showing bearish divergence
  • Price bouncing from resistance
  • Bearish price action

You can see from the USD/JPY 4-hour chart below that all of the above sell trade conditions have been met. The RSI is above 30 and showing bearish divergence. The MACD crossover has happened to the downside and there is also bearish divergence on the MACD indicator. Price is forming lower levels of resistance which suggests that buyers are losing momentum. We have lots of bearish candlestick patterns including a big red engulfing bar. We could have placed the stop loss just above the recent swing high which would have been around 30 pips. That is not bad when you consider that this down trend lasted for over 700 pips.

RSI Trend Strategy Sell Signal
RSI Trend Strategy Sell Signal

RSI trend strategy Pros & Cons

Pros

  • Catch some good trends
  • Help to avoid buying high and selling low
  • Can be used on any currency pair and timeframe
  • Can be combined with other forex indicators
  • RSI indicator is free to use
  • Easy to identify signals

Cons

  • Need to time entry and exit
  • Need good money management
  • There can be lots of false signals

Conclusion: is the RSI trend strategy any good?

Yes, I think trading in the direction of the trend using the RSI indicator can be very powerful when used correctly. This is a simple RSI strategy once you understand how it works but it does require some initiative on behalf of the user in terms of filtering and confirming the signals using price action analysis, including support and resistance along with candlestick patterns.

Just like with any forex trading strategy, you will need to be using sensible stop loss and take profit levels to help improve your chances of success in the long term. I too often see trading systems that use wide stop losses with tight take profit levels. I would prefer to cut losing trades short and let winning traders run. A trailing stop could be used to try and maximise each move.

For instance, if you had a 100 pip stop loss and 20 pip take profit, 1 bad trade would wipe out 5 winners, not including brokerage fees. If you had a 20 pip stop loss and 100 pip take profit, you could have a win rate below 50% and still make some pips.

If you want to give the RSI trend trading strategy a try out, perhaps start on a demo account to begin with. You can get a free demo account from most forex brokers which can be a good way to practice your trading strategies and improve your skills before making any commitment. Once you have gained enough experience and confidence, you can always consider making the switch over to a live account.