The RSI is a technical indicator, enabling you to evaluate a trend’s momentum and to use this knowledge to become a better trend based trader. Binary options operate with too short expiration times to be influenced by fundamental reasons like a company doing well or economical data. Instead, your success as a binary trader depends on your ability to interpret market movements, recognize patterns, and draw predictions.
Therefore, one of the most important tools of each is trader is trend analysis. The RSI can take your trend analysis skills to the next level.
How to use the Relative Strength Index (RSI)
The RSI’s main purpose is to allow a trader to draw conclusions about how much potential a trend has left. To do that, it calculates the ratio of higher closes to lower closes over an adjustable time span, most commonly 14 periods. For each of the last 14 periods the closing price is compared to the closing price of the previous period. All the periods with rising prices are added up and set in relations to the periods with falling prices.
The RSI is an oscillator. This means, it ranges between 0 and 100. If all the calculated periods had rising prices, the RSI will approach 100. If all periods had falling prices, the RSI will approach 0. In most cases, the RSI is not drawn into the price chart, but visualized in a separate chart below the price chart, as you can see in the picture above.
How to interpret the RSI
The RSI generates very easy to interpret signals. In theory, all values over 70 indicate overbought markets, and all values under 30 indicate oversold markets.
The RSI works on the assumption that once every trader willing to buy an asset has bought, there is no momentum left to enable further rising prices. The asset has to go through a phase of consolidation first to create new demand, before it can continue to rise again. If the market is too overbought, it will not only enter a consolidation, but turn around. The same logic applies to a downtrend. Once everybody willing to sell has sold, demand has to exceed supply. Therefore, prices must rise.
The RSI can help you identify such overbought or oversold time periods.
You can use it for your trading to fine tune your strategy and eliminate bad signals. For example, you could make it a rule to never invest in rising prices of an asset with an RSI over 70 (overbought), and to never invest in falling prices of an asset with an RSI under 30 (oversold). This rule can help you win a higher percentage of your trades, and make your strategy more secure. On the other hand, your strategy will generate fewer signals and therefore lose some of its earning potential.
Still, the RSI is a good instrument to find out how trustworthy a trend still is.
How the RSI can benefit your trading
If you have traded a trend at least once in a life, you know the inevitable fear of each trader that, although a trend has been intact for a long time, sometimes even for years, this time, right at the moment the trader invests in it, the trend will stop and the trader will lose all its money. Also, many traders are afraid of trading the movement from point 3 to point 2 in a trend, because they don’t know how long it will last. They fear, once they invest in the movement, prices will turn around and enter the reversal.
Of course, most times this fears are unjustified, and can only lead to making bad decision. Therefore, we will present you with a technical indicator to judge the potential a trend and a movement has left. While this is no absolute solution, it can help you deal with your fear and judge a trend based on facts, not your emotions.