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Page 3 of 8 How to Use RSI in Trading
RSI can be used to determine overbought/oversold levels
Overbought/Oversold
If RSI is above 70, the pair is considered to be overbought. Some traders enter short at this point, but this can be dangerous as the price may still be rising. Enter short when the RSI crosses back under 70, as this may indicate that the momentum has turned. If the RSI is below 30, the pair is considered to be oversold; enter when RSI crosses back above 30. Like most oscillators, RSI works best when the market is range-bound – in other words, when the market is expected to simply gravitate between an upper and lower level
Simple Moving Average (SMA) - The average price of a currency pair over a given time period, (15 minutes, 1 hour, 1 day, etc.) where each period in the average is weighted equally. Since this indicator is widely used by day traders and swing traders in many markets, it is important to understand how it is calculated. A basic example to calculate the 4-day SMA will demonstrate this.
Example (using closing prices of the EUR/USD):
Day 1 Close = 1.1210
Day 2 Close = 1.1250
Day 3 Close = 1.1220
Day 4 Close = 1.1240
SMA (4) = (1.1210 + 1.1250 + 1.1220 + 1.1240) / 4 = 1.1230
Consequently, the average price of the Euro - U.S. Dollar during the four days shown above is 1.1230.
Exponential Moving Average (EMA) - Unlike the SMA that gives equal weight to all prices, the exponential average gives more weight to the most recent currency prices. The purpose of the exponential weight is to give more importance to the most recent data in the determination of trend direction.
Moving Averages are one of the most popular and easy to use tools available to the technical analyst. By using an average of prices, moving averages smooth a data series and make it easier to spot trends. This can be especially helpful in volatile markets.
The formula for an exponential moving average is:
X = (K x (C - P)) + PX = Current EMA
C = Current Price
P = Previous period's EMA*
K = Smoothing constant
(*A SMA is used for first period's calculation)
The smoothing constant applies the appropriate weighting to the most recent price relative to the previous exponential moving average. The formula for the smoothing constant is:
K = 2/(1+N)
N = Number of periods for EMA
For a 10-period EMA, the smoothing constant would be .1818.
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