Forex trading is numbers driven. An important series of numbers are “indicators”, a type of metric. One of these is called the Relative Strength Index, or RSI for short. This often-used momentum indicator is used to compute oversold and overbrought positions for a given currency. Developed by J. Welles Wilder in 1978, it uses a basic calculation for the purpose of identifiying market momentum. The possibilities range from between 0 to 100.

The formula itself is:

Relative Strength Index = 100 ? [100 / (1 + RS)]

RS indicates the relative strength over a certain time frame. It is computed by dividing the average gain by the average loss.

The average gain and average loss are computed on the basis of a certain time frame, normally 14 market days. If we examine the dynamic at play, RSI rises as the average gain goes up. Conversely, as the amount of average loss ruses, RS and RSI value declines. The relative strength index is a continual process and the market comprehension improves over time as increasingly detailed and more accurate data are available.

The most valuable aspect of the relative strength index is the ability to determine oversold and overbought positions. As an example, when the RSI is 70 or greater, the currency is rendered as overbought and on the flip side, when less than 30, it is thought of as oversold. As always, more usable and reliable results will be generated when RSI is used in conjunction with a toolbox of other research devices.

How does the RSI indicator operate specifically in the forex arena? Although RSI has the moniker of an overbought/oversold indicator, be aware that RSI does not supply “buy/sell” signals which indicate oversold/overbought positions. Be that as it may, there do exist specific guidelines that assist the trader in figuring out optimal timing for entries and exits in given currencies.

In order to identify those overbought and oversold currency pairs, forex traders examine two different RSI levels: 30 and 70. Computations greater than 70 would mean an overbought market. On the other side of the spectrum, readings less than 30 would mean an oversold currency.

In summary, experienced traders know that in those times when a healthy uptrend exists, a reading above 70 is expected while the reverse is the case for readings less than 30.

To properly use the RSI data, some skill is needed. Generally, traders would be well-advised to give the RSI some time to leave the overbought or oversold region.

The Relative Strength Index is just one tool available to the forex trader, and one that has proven helpful to many traders in the past. By taking the time to learn how to use it properly and also in conjunction with other indicators, you will be much better positioned to take advantage of many different forex currency market conditions.