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TECHNICAL ANALYSIS

Using RSI as an Intraday Tool

technical-analysis-rsi-intraday-trading-signals

The Relative Strength Indicator, created by Welles Wilder, has long been used by many market participants in their analysis. For the most part this application has been applied via daily charts, or longer periods, primarily as a means to identify trend. But there are a number of methods that RSI can be used for;

• As a measure of an overbought/oversold situation.

• An indicator of the underlying trend & of trend breaks.

• A buy/sell signal when the 50% line is crossed.

• An indicator of possible Divergence

For the investor or proprietary trader these methods are without doubt tools that, taken in context with other technical indicators, will prove useful. But do they work, and can they be successfully employed, in shorter intraday time frames?

In this article I will use the same hourly GBPUSD chart, and the same 8 period RSI, and apply the four methods above to illustrate how to use them and assess whether they’re likely to be beneficial.  Lastly I’ll add a lesser known but powerful approach that I find invaluable in assessing likely intraday price action.

RSI Overbought/Oversold

technical analysis rsi intraday trading signals RSI OBOS

This technique is quite straightforward in that oversold readings, i.e below 25%, are used as alerts that the market is ripe for a change of direction to positive. The same applies to overbought indications – in other words when RSI registers above 75% then the potential arises for a downward move.

Obviously in such circumstances confirmation is needed in the shape of candle formations that provide clear bullish/bearish signals.

As you can see from the above chart where overbought is marked by red shading and oversold by blue, it’s a bit of mixed bag. The significant highs/lows are naturally marked by the relevant shading but a number of other situations were only warnings of what turns out to be minor profit taking rallies inside the more pronounced trend.

RSI Trend Indicator & Breaks

technical analysis rsi intraday trading signals RSI TREND

This is an interesting way of using RSI price action as opposed to the actual RSI reading. The line movement of the indicator is used in the same way as the price action – i.e.to draw trendlines from significant peaks or troughs as an indication of trend. When the trendline is broken the direction of movement changes.

There are, perhaps, a number of other less pronounced trends I could have used on this example but I’ve highlighted 3 clear instances. In each of the cases above while the trends on the spot price and the RSI are almost mirror images, the break of the RSI line is marginally ahead of the spot price breach. Interestingly, and while not exclusively, it rarely lags by a noteworthy degree.

RSI 50% Line

technical analysis rsi intraday trading signals RSI HALFLINE

The element here is that the 50% marker on the RSI reading is pivotal. In other words a crossing of that point upward is indicative of a bullish trend while a ‘negative’ cross confirms a bearish bias.

Stepping back from the red marking, that show each crossover, you can see that the underlying tone of the market is reflected by the fact that RSI is above/below the 50% line. However as a tool to Buy/Sell on moves through the line it clearly is worse than any of the other methods with volatile moves creating false breaks too much of the time for the indicator to be anything other than worthless for actual trading (though not for an appreciation of a key background element to market psychology).

RSI Divergence

technical analysis rsi intraday trading signals RSI DIVG

Looking for an indication of divergence is a more interpretive, rather than mechanical, method. What we’re looking for is a lower price low but where RSI readings move higher, contradicting the spot movement rather than matching it, or a higher price high where the RSI reading is lower on the 2nd occasion.

In this same example, covering only a limited period of time, there are 5 examples. All three bullish divergences and both bearish divergences proved correct, predicting a change in direction for GBPUSD. The main issue with this style of RSI signals is that very often it is subjective and confirmation can be given too late for significant returns.

What can be clearly seen in the above examples is that experienced use of the RSI indicator can be a rewarding tool for even short term trading. But let’s move on to the 5th application that I mentioned at the start of this piece;

Moving Average of RSI

technical analysis rsi intraday trading signals RSI MVGAVG

Here the RSI is adapted by overlaying a moving average of the actual RSI readings rather than of the spot prices. The cross of the RSI above or below the moving average giving a buy or sell trigger. The moving average used here is a simple one of 21 periods but, crucially, displaced/offset by 13 periods. As I’ve mentioned in a previous article of FX Trader Magazine (January-March 2012), the displaced moving average has the ability to filter out a great deal of noise and greatly enhances the efficiency of the tool.

You can see above there are 8 triggers and all but 2 give significant follow through and only one can be regarded as giving an incorrect signal – the correct sell signal being given a few hours later. It is clear that this technique of adapting RSI to intraday trading can be of substantial use. Now we’ll use another currency pair and drill down to a shorter time frame;

This next chart shows 15 min EURUSD which is about the lowest time frame I feel gives a perspective to trade a trend inside the day.

technical analysis rsi intraday trading signals RSI EURUSD

In this example there are 6 triggers and only the 2nd and 6th did not provide opportunities for a profitable trade (the 6th actually resulted in a sideways move that would eventually have been closed for little movement). The shorter time frame you adopt the greater the scope for a lack of direction whether in quiet trading or volatile price action, however this manner of using a moving average of RSI readings continues to provide buy and sell triggers with a good percentage of moves that give significant potential for profitability.

I hope this article provides you with grounds for thought and an interest in trying intraday RSI signals for yourself.

Alan Collins