How to Trade with RSI: From Beginner to Advanced Traders

The Relative Strength Index (RSI) is one of the most famous momentum oscillators in a technical trader’s toolkit. It measures the speed and change of price movements, and is widely used by traders to identify overbought or oversold conditions in a market. By understanding RSI, traders can better time their trades and make informed decisions.

Read this article because it provides practical strategies and tools for effectively trading with RSI, helping you identify optimal entry and exit points to improve your trading success!

I’ll answer the following questions:

What is the Relative Strength Index (RSI) in technical analysis?
How do you use RSI in day trading?
What is the overbought/oversold (OBOS) trading strategy with RSI?
How can you trade RSI divergences effectively?
What is the failure swing trading strategy with RSI?
How do Cardwell’s positive and negative reversals work with RSI?
What are the best RSI settings for different trading styles?
What are the limitations of RSI and how can they be mitigated?

Let’s get to the content!

What Is RSI?

The Relative Strength Index (RSI) is a technical indicator developed by J. Welles Wilder Jr. It is used to measure the strength of recent price changes — it will then tell you whether they are “overbought” or “oversold”. RSI is one of the most popular indicators in trading due to its simplicity and effectiveness.

RSI plays a big role in identifying overbought or oversold conditions in an asset. When the RSI reading is above 70, the asset is generally considered overbought, indicating a potential pullback. On the other side, an RSI below 30 suggests that the asset might be oversold, implying a possible upward reversal. This information can help traders identify entry and exit points.

The formula for calculating RSI is as follows:

RSI = 100 – (100 / (1 + RS))

RS (Relative Strength) = Average Gain of N periods / Average Loss of N periods

N typically defaults to 14 periods

How to Use RSI in Day Trading

RSI is a vital tool for day traders, helping them identify potential market reversals and trend strength. By incorporating RSI into their trading strategies, traders can make more informed decisions, reduce risk, and improve their chances of success.

Here are some examples of RSI day trading strategies:

Overbought/Oversold Strategy: Buy when RSI is below 30 (oversold) and sell when RSI is above 70 (overbought).
RSI Divergence: Look for divergences between RSI and price action to identify potential reversals.
RSI Trendline Breaks: Use trendlines on the RSI itself to spot changes in momentum and trade accordingly.

Adjusting the period length of the RSI can tailor the indicator to fit your trading style and the timeframes you’re trading. Shorter periods, like a 7-day RSI, offer more sensitivity, providing quicker signals for dynamic markets. In contrast, longer periods, such as a 21-day RSI, smooth out the data, reducing false signals. Finding the right balance for your strategy is the best way to use RSI for day trading. To see all the ways I tailor RSI for day trading timeframes, check out my guide on RSI settings for day trading.

How to Trade With the RSI Trading Indicator

Trading with the RSI indicator can help investors identify significant price movements and potential trend reversals. The RSI indicator provides insights into whether prices are in an uptrend or a downtrend, guiding traders on when to enter or exit trades. By analyzing the RSI in conjunction with other technical tools, like candlestick patterns, traders can increase their chances of making profitable trades.

One key advantage of using the RSI indicator is its ability to highlight overbought and oversold conditions, which can signal potential price reversals. This can be particularly useful in varying timeframes, whether you’re day trading or looking at longer-term investments. Understanding the risk-reward ratio is crucial; the RSI helps in managing risks and maximizing profits by indicating when a price move might be exhausted.

In my years of trading and teaching, I have seen how effectively combining RSI with other indicators can lead to better trading decisions. I use the RSI in a holistic manner, taking into account the broader market context to minimize losses and optimize gains. This article aims to provide a solid foundation for using the RSI effectively in your trading strategies, ensuring you make informed decisions based on comprehensive analysis.

You’ll need a top-rate charting program to trade with RSI. I use StocksToTrade.

StocksToTrade has the trading indicators, dynamic charts, and stock screening capabilities that traders like me look for in a platform. It also has a selection of add-on alerts services, so you can stay ahead of the curve.

Grab your 14-day StocksToTrade trial today — it’s only $7!

Breakout Trading Strategy

A breakout trading strategy aims to capture significant price movements after the price breaks through a resistance or support level. RSI can help identify these breakouts by signaling when momentum is building.

To implement a breakout trading strategy with RSI:

Identify key support and resistance levels on the price chart.
Wait for the RSI to move above 70 or below 30 to confirm momentum.
Enter the trade as the price breaks the support or resistance level.
Set stop-loss orders just below the breakout point to manage risk.
Monitor RSI to exit the trade when momentum weakens.

Overbought/Oversold (OBOS) Trading Strategy

Overbought and oversold levels are critical concepts in RSI trading. They indicate potential reversal points, offering traders opportunities to enter or exit trades.

Guidelines for entering and exiting trades based on OBOS signals:

Enter long positions when RSI falls below 30 (oversold) and starts to rise.
Enter short positions when RSI rises above 70 (overbought) and begins to fall.
Exit long positions when RSI approaches 70.
Exit short positions when RSI nears 30.

Divergence Trading Strategy

Divergence occurs when the price moves in the opposite direction of the RSI. This can signal a potential reversal, making it an essential concept in trading.

To spot and trade RSI divergences:

Identify when the price makes a new high or low, but the RSI does not confirm it.
Look for bullish divergence when the price makes a lower low, and RSI makes a higher low.
Look for bearish divergence when the price makes a higher high, and RSI makes a lower high.
Enter the trade when the RSI divergence is confirmed by price action.

Another divergence RSI technique to consider is the Triple RSI strategy, which involves using multiple RSI indicators with different timeframes to confirm signals and reduce false positives. This method helps traders identify stronger and more reliable divergence signals. By comparing short, medium, and long-term RSI values, traders can gain a comprehensive view of market momentum and potential reversal points. Integrating this strategy can refine your divergence trading approach, making it more robust and effective. For a detailed breakdown of how to implement this technique, check out my article on the Triple RSI strategy.

Failure Swing Trading Strategy

A failure swing occurs when the RSI fails to move above a previous high or below a previous low, signaling a potential reversal.

Steps to trade RSI failure swings:

Identify when the RSI fails to surpass its previous high (bearish failure swing) or drop below its previous low (bullish failure swing).
Enter a short position on a bearish failure swing.
Enter a long position on a bullish failure swing.
Set stop-loss orders above the recent high or below the recent low to manage risk.

Cardwell’s Trend Confirmations Trading Strategy

Andrew Cardwell’s approach to using RSI involves confirming trends rather than just spotting reversals. Cardwell identified positive and negative reversals as trend confirmation signals.

Criteria for trend confirmation using RSI according to Cardwell:

Positive reversals occur when the price makes a higher low, but RSI makes a lower low.
Negative reversals occur when the price makes a lower high, but RSI makes a higher high.
Use these reversals to confirm the continuation of the current trend.

Cardwell’s Positive and Negative Reversals Trading Strategy

Cardwell’s positive and negative reversals are advanced RSI techniques that help confirm trend direction.

Examples of identifying and trading Cardwell’s reversals:

Spot a positive reversal when RSI makes a lower low, but the price makes a higher low. Enter a long position.
Spot a negative reversal when RSI makes a higher high, but the price makes a lower high. Enter a short position.

A lot of traders have tinkered with RSI and put their names on the results — Larry Connors is another. Connors RSI combines the traditional RSI with two additional components: the UpDown Length and Rate of Change, providing a more nuanced view of price momentum. This approach helps in identifying shorter-term reversals within the broader trend, offering more precise entry and exit points. Check out this detailed guide on Connors RSI trading strategy for a deep dive into another niche method!

Potential Buy & Sell Signals

RSI can generate potential buy and sell signals, helping traders identify optimal entry and exit points.

Conditions that typically indicate buy or sell signals with RSI:

Buy signal: RSI crosses above 30, indicating the asset is recovering from oversold conditions.
Sell signal: RSI crosses below 70, indicating the asset is pulling back from overbought conditions.

RSI Divergences

Divergence trading with RSI is a powerful technique for spotting potential reversals. It involves comparing the direction of the price movement with the direction of the RSI.

Examples of bullish and bearish divergences:

Bullish divergence: Price makes a lower low while RSI makes a higher low.
Bearish divergence: Price makes a higher high while RSI makes a lower high.

RSI Failure Swing: Bullish & Bearish

Bullish and bearish failure swings are critical RSI patterns that can signal potential reversals.

To trade both bullish and bearish failure swings with RSI:

Bullish failure swing: RSI fails to drop below a previous low, then rises above a recent high. Enter a long position.
Bearish failure swing: RSI fails to rise above a previous high, then drops below a recent low. Enter a short position.

What RSI Settings Can Be Used?

The standard RSI setting is 14 periods, but traders can adjust this to suit their strategies. Shorter periods make the RSI more sensitive to price changes, while longer periods smooth out the RSI readings.

How changing RSI settings affects the indicator’s sensitivity:

Shorter periods (e.g., 7) increase sensitivity, generating more signals but also more noise.
Longer periods (e.g., 21) decrease sensitivity, providing fewer but more reliable signals.

If you’re new to trading and want to know more about your technical indicator options, check out this video:

Interpretation of RSI and RSI Ranges

Interpreting RSI values is essential for understanding market conditions. An RSI above 70 suggests an overbought condition, while an RSI below 30 indicates an oversold condition.

Typical RSI ranges and their meanings:

70-100: Overbought, potential for price pullback.
30-0: Oversold, potential for price rebound.
50: Neutral, indicating balanced market conditions.

Limitations of the RSI

While RSI is a valuable tool, it has limitations. Relying solely on RSI can lead to false signals, especially in trending markets where the RSI may remain in overbought or oversold levels for extended periods.

Importance of combining RSI with other indicators and analysis methods:

Use alongside moving averages to confirm trends.
Combine with MACD to validate signals.
Incorporate support and resistance levels to enhance decision-making.

Key Takeaways

RSI is a momentum oscillator that measures price changes to identify overbought and oversold conditions.
It can be used in various trading strategies, including breakout, OBOS, divergence, and failure swing strategies.
Adjusting RSI settings can affect its sensitivity to price movements.
RSI is most effective when combined with other technical indicators and analysis methods.
Be aware of RSI’s limitations and use it as part of a broader trading strategy.

There are a ton of ways to build day trading careers… But all of them start with the basics.

Before you even think about becoming profitable, you’ll need to build a solid foundation. That’s what I help my students do every day — scanning the market, outlining trading plans, and answering any questions that come up.

You can check out the NO-COST webinar here for a closer look at how profitable traders go about preparing for the trading day!

What indicator do you use when you’re trading? Write “I won’t trade without a plan” in the comments if you’re ready to trade the right way!

Frequently Asked Questions

What Is the Success Rate of the RSI Trading Strategy?

The success rate of RSI trading strategies varies depending on market conditions and how the indicator is used. Combining RSI with other indicators and employing proper risk management can enhance its effectiveness.

What Is the Best Indicator Combination with RSI?

The best indicator combinations with RSI include moving averages, MACD, and Fibonacci retracements. These indicators can help confirm signals and improve trading accuracy.

Is RSI a Good Trading Strategy?

RSI is a valuable tool for traders, but it should not be used in isolation. Combining RSI with other indicators and analysis techniques can provide a more comprehensive trading strategy and improve results.

What Is the Importance of Risk Reward in RSI Trading?

Risk reward is crucial in RSI trading as it helps traders evaluate potential profits against potential losses. By analyzing the RSI (Relative Strength Index) in conjunction with risk reward ratios, traders can make informed decisions about entering and exiting trades. Balancing risk and reward ensures that the number of successful trades outweighs the unsuccessful ones, leading to a favorable trading conclusion over time.