There are many ways you can identify the trend on a price chart. You can use trendlines, price action, or moving averages. But in this article, I’m going to show you how to identify the trend with RSI indicator.
Many traders use RSI indicator to determine if the asset is either overbought or oversold. The RSI indicator can also be a good trend indicator.
A trend is the way prices move on a chart over a period of time. Prices can move upward, downward, and sideways. Most of the time, you can have currency pairs moving in all three directions on different time frames at the same time. For example, a daily chart of EURUSD shows an uptrend, while a 4 hour chart is moving sideways and a 15min chart is breaking the trendline and moving down. All at the same time.
Finding the trend on a chart can be challenging and many traders have difficulties identifying properly the prevailing trend on a price chart.
You’ve probably heard the famous quote “The Trend is your Friend.”
This quote implies that as long as you are trading in the direction of the major trend, you’re okay! If you place a trade in the opposite direction of the major trend, it’s a losing trade.
If prices are rising, would you be willing to buy or sell a currency pair? Of course you’ll be willing to buy! You want to make profits as prices are going up.
As long as you go with the trend, you have an opportunity to make money on the market. If you decide to go against the trend, the market will punish you by taking your money out of your trading account.
So without further ado, let’s get started!
What is RSI?
The RSI or Relative Strength Index is a momentum indicator used by technical analysts to measure price changes of a specific asset (forex pairs, stocks, or commodities).
Traders use the RSI indicator to evaluate overbought and oversold conditions and to identify changes in price momentum.
How do you read RSI indicator?
When you add the RSI indicator on your chart, the RSI gives a reading from 0 to 100. The RSI line oscillates between these values to evaluate whether the currency pair is in oversold or overbought conditions.
The default settings of RSI indicator show two horizontal lines: the first line has a value of 30 and the other line has a value of 70.
Technically, a reading above the value of 70 indicates that the currency pair is overbought and a reading below the value of 30 indicates that the currency pair is oversold.
Here’s an example, when the RSI indicator gives an oversold reading (below the value of 30), it signals a bullish momentum and price goes up. When the RSI is overbought (above the value of 70), it signals a bearish momentum and price goes down.
Except for the last reading on the right side of the chart, the RSI gives an overbought signal but price failed to move down and continued moving higher.
The RSI indicator is considered a lagging indicator, which means that we can’t use it to forecast future price action. But we can use it to get market confirmation as we align its signal with other indicators or price action to trade the market.
How do you set RSI parameters?
In order to identify the trend with RSI indicator, we need to change the settings to use it as a trend indicator.
Go to the RSI settings and change the following parameters:
- Remove the 30 line,
- Change the upper band from 70 to 50,
The indicator now oscillates around the 50 value line as we can see on the chart below. This line is what we’ll use to identify the trend.
If you are using MetaTrader 4 platform, you can change the RSI parameters by simply adding the 50 value line under “Levels”, this will add the 50 value line.
Here’s what your chart on MetaTrader will look like:
Now that we changed the settings of the RSI indicator and we’ve added the 50 value line, I will show you how to use the new settings to determine the trend on a price chart.
Determine the trend with RSI indicator
When the RSI indicator is trending above the 50 value line, it means that the market is in a bullish momentum and we only take buy signals and we ignore sell signals.
When the RSI indicator is trending below the 50 value line, it means that the market is in a bearish momentum and we only take sell signals and we ignore buy signals.
1. RSI signal for an uptrend
The trend is up when the RSI indicator trends above the 50 value line. This confirms a bullish momentum as price starts trending higher.
The chart below shows an example of an uptrend followed by the RSI crossing above the 50 line. Normally, we want to see the RSI line cross the 50 line and move away from it. This signals a bullish momentum that will push prices higher.
We don’t want to see the RSI line diddling above the 50 line. This signals a weak bullish signal and price might either go in the direction of the previous trend or start moving sideways.
On the RSI indicator, we can see clearly that the RSI crosses the 50 line and moves away from it quickly.
2. RSI signal for a downtrend
The trend is down when the RSI indicator crosses below the 50 value line. This confirms a bearish momentum and price declines.
The chart below shows an example of a nice downtrend and the RSI line trending below the 50 line. We want to see the RSI line crossing the 50 line and moving away from it quickly to consider the signal valid. If the RSI line keeps trending around the 50 line, the signal is weak.
3. RSI signal for sideways trend
When price is moving sideways, the RSI line is trending close to the 50 value line. The chart below shows that the RSI keeps trending back and forth around the 50 line.
You can add two more lines around the 50 line to spot sideways trends easily: the first line at the value of 40 and the second line at the value of 60. As long as the RSI line is bouncing between 40 and 60 lines, you consider it a sideways trend.
The following example shows the 3 trends: uptrend, downtrend, and sideways trend.
- During an uptrend, the RSI indicator is trending above the 50 line.
- During a downtrend, the RSI indicator is trending below the 50 line.
- During a sideways trend, the RSI indicator is trending close to the 50 line (between 40 and 60 lines).
The trend is your friend, as long as you trade in the direction of the major trend. Because prices don’t move in a straight line, determining the trend can be quite challenging, especially for beginners.
The RSI indicator is a great technical tool if used properly. In our case, we use it as a trend indicator to help us find the trend is just one glance. The indicator also helps us to stay away from trading when the market is ranging.