Relative strength index trading strategies

Secondly, it is advisable to try to trade with the trend where possible, and given there are a lack of oversold signals, we need to adjust the parameters to account for the market bias. Shifting the oversold territory to 35 (based on the prior two retracements), it is clear that we are now in a position where this market could turn higher once again. This bullish bias is confirmed by the existence of Fibonacci support.

RSI divergence

A divergence occurs when momentum fails to follow price action in the creation of peaks and troughs. For an uptrend, you want to see the RSI create new higher highs, alongside price action. When momentum creates lower highs, while the price forms higher highs, it is a sign that the market could be about to turn.

The example below shows it in action, with EUR/GBP first seeing a bullish divergence, followed swiftly by a bearish divergence. The creation of a new low in late September came alongside a higher low on the RSI. This was followed by bearish divergence, where the RSI failed to follow the higher highs being set by the price, with said price subsequently following it lower.

It is important to always await a signal in price action to confirm the potential reversal highlighted by a RSI divergence. On this occasion, the trendline break provided a supplementary reversal signal.

Failure swings and RSI formations

The failure to create a new higher high (uptrend), or lower low (downtrend) in the RSI is called a failure swing. These failure swings can be utilised across a number of methods, with standard technical analysis patterns coming into use. This means patterns such as head and shoulders, double tops, wedges and the like can be utilised as potential reversal signals.

The USD/CAD chart below highlights a market reversal, with the double top formation on the RSI paving the way for a turn in price action. Once again, utilising price action alongside the RSI would have provided higher degree of accuracy, selling on the break below $1.3816. However, on this occasion, we see that it would have given a delayed signal.