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Unorthodox RSI trading strategies

By Capital.com Research Team

16:00, 1 October 2021

RSI trading strategies
Source: Shutterstock

The Relative Strength Index (RSI) is a popular technical analysis tool that can be used in several unorthodox ways to determine the future movement of an asset. 

Reminder: What is the RSI in trading?

The RSI is a momentum oscillator created by J Welles Wilder Jr and was published in his book New Concepts in Technical Trading Systems in 1978. The conventional use of the RSI indicator is to measure momentum and determine if prices have accelerated too quickly. Most traders use the RSI as a contrarian indicator, looking for turning points where an asset will change direction. 

While using the RSI as an overbought or oversold indicator can be helpful, the three unconventional RSI strategies provided here can offer unseen trading opportunities. 

Why change technical Indicator settings?

As you develop your trading style, you can consider different strategies to enhance success. Many traders use technical analysis to help them gauge the future movements of a security. Technical analysis is the study of past price movements to help you determine the future direction of an asset. (Although, of course, past performance is no guarantee of future results!)  There are dozens of different technical indicators. Each uses a standard-setting that the creator of the study likely published. 

For example, when J Welles Wilder Jr published the RSI, he used 14 days as the benchmark. All of his analysis stemmed from using this period to gauge whether an asset was overbought or oversold.

Fortunately, markets are constantly changing. To keep up with the times and customize an indicator to your trading strategy, you should consider altering an indicator to meet your needs. For example, if you use a long-term trading strategy, you might consider changing the period to 28-days or using weeks or months instead of days. If you are short-term trading, you could change the lookback period to ten days. 

The standard RSI trading strategy

Technical analysis techniques allow you to see the trends in the marketplace as well as gauge momentum. Momentum is the acceleration in the price of an asset. 

The RSI is used to see how much an investment has accelerated over a specific period. The index generates a number that oscillates between 1-100. The strategy Wilder describes uses the RSI to gauge whether the price of a security is overbought or oversold. 

A reading on the RSI below 30 is considered oversold. Readings above 70 are considered overbought. Conceptually you would look for an opportunity to buy an investment when the RSI prints a level below 30. 

Conversely, you would look to sell or short an asset when the RSI publishes a reading above 70. You will find that the RSI can remain overbought or oversold for an extended period at times. 

Yet there are also several unorthodox RSI strategies that can help you find different levels to enter a trading position.

CHART

A second way Wilder described using the RSI was to find periods of divergence. Divergence occurs when momentum has stalled, but prices continue to move in the direction of the trend. 

A split between prices and the RSI can also happen when momentum is trending but prices have stalled. In each of these cases, the RSI tells you about the rate of change relative to price action, which can give you clues about the future direction of your investment.

Unorthodox RSI trading strategies

RSI-based trading strategies allow you to use momentum to determine the future direction of your investment. Three unconventional RSI strategies include positive and negative reversals, bullish and bearish ranges, and RSI trend lines. Each unorthodox strategy can be used in conjunction with other RSI trading techniques. 

1. RSI Crossover

When the RSI prints a reading that is either overbought or oversold, it does not provide you with a specific indication that a reversal has occurred. If you are using the RSI to trade, you want a trading signal that can help you determine when to enter. 

Crossover signals are an unconventional way to create an RSI indicator trading strategy. You can also use the RSI to help you generate a signal. 

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Gold

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Spread 1.50

For example, in the chart of gold below, you can see the standard RSI of gold shown under the price of gold. A bullish or bearish signal is when the RSI crosses back above or back below the signal range. When the RSI crosses below 30 and then travels back above 30, a reversal signal is created. 

On the other hand, a sell signal is generated when the RSI crosses above 70 and then crosses back below 70. This strategy will tell you when the price exceeds overbought or oversold territories and can help you avoid entering a trade too early.

CHART

2. RSI range shift

The analysis of Wilder's RSI gives many ways of using RSI to trade, yet none are more prominent than RSI bullish and bearish ranges. The ranges, which were created by Andrew Cardwell using Wilder's standard RSI, unveil further insight into momentum.

The RSI usually remains static during uptrends compared to downtrends. That is because uptrends are typically smooth, like a staircase. Downtrends are generally sharp, and many markets fall at more than twice the rate compared to their ascent. 

Since the RSI measures gains versus losses, the RSI will stay at higher levels during an uptrend. During a downtrend, the RSI will remain at lower levels. 

Cardwell introduced RSI ranges to help determine where in the trend a market is trading. The ranges include the positive and negative territory, overbought and oversold levels as well as extreme overbought and oversold levels. 

According to this strategy, bullish fields are from 50-70 but start near 40 and usually end near 80. Bearish levels are from 30-50 but can begin near 60 and end at 20.

CHART

You can use Cardwell’s ranges together with other indicators to help determine where you are in a trend cycle and the likelihood of the trend continuing in a specific direction. 

For example, if you experience a trend line price breakout and the RSI is near 70, according to this strategy the trend could continue to rise as the RSI range is in bullish territory. 

If the same scenario happens at 80, the strategy suggests that the RSI is in extreme overbought territory and might not continue to trend higher. Cardwell also states that equities have historically trended higher and therefore the bullish levels can extend downwards to 40. 

3. RSI Trendlines

Another RSI-based trading strategy that focuses on RSI unconventional usage is drawing trendlines on the RSI. Since the RSI is a momentum oscillator, a trend line will help you determine momentum direction. You can draw a downward or upward sloping trend line, which if broken shows you that the momentum has reverted.

Note that drawing a trendline is somewhat subjective. A guideline that you can use is connecting two or more points and extending the line to see support and resistance levels. 

You can also use trend lines to see if a market is diverging. Divergence occurs when momentum is stalling, but prices are not. If the RSI reaches resistance and does not climb higher, but price action is rising, momentum and price movements are diverging, which could signal that a trend is running out of steam. 

You can see on the USD/JPY chart below that the breakouts and breakdown in the RSI coincide with the upward breakout and the downward breakdown of the exchange rate.

CHART

Edited by Jekaterina Drozdovica

FAQs

How do RSI strategies work?

An RSI strategy uses momentum to determine whether a market is trending or overbought, or oversold. Readings of the RSI index above 70 are considered overbought while readings of the RSI below 30 are oversold.

How to use RSI strategies

The common use of the RSI is to look for overbought and oversold readings. Other unorthodox RSI strategies include positive and negative reversals, bullish and bearish ranges, and RSI trend lines.

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