Trading Strategy

How to Use RSI Indicator For Day Trading Strategies

August 8, 2021 | 12:51 pm | The 5%ers' Blog > Trading Strategy
August 8, 2021 | 12:51 pm
The 5%ers' Blog > Trading Strategy
How to Use RSI Indicator For Day Trading Strategies

RSI Trading Strategy

Ah, the good ol’ technical indicators. They let you determine where the price is heading next.

Among these indicators is the RSI.

The RSI is popular among the trading community, especially day traders, as it gives you an idea of future price trends.

But how can you use the RSI indicator for day trading?

In this guide, we are going to dig deeper into how you can apply the RSI for your day trading strategies.

First, let’s briefly discuss the RSI indicator.

 

RSI Explained in 200 words

The Relative Strength Index (RSI), developed by J. Welles Wilder, is a momentum oscillator that measures the speed and change of price movements.

The RSI oscillates between zero and 100.

Overbought is defined as a price value greater than 70. If the figure is less than 30, it indicates an oversold position, and the price will rise in the future.

50 act as a neutral level, and you must wait for the price to fall or climb before entering positions.

How to read RSI indicator

As the above chart illustrates, when the RSI dips below 30, it shows oversold levels, and when it is above 70, it is in the overbought level.

When the price of an asset is above 70, it is a sign of a trend reversal, and you should exit long and enter short positions. On the other hand, if the RSI is below 30, you can take long positions.

During trends, the RSI readings may fall into a band or range. During an uptrend, the RSI tends to stay above 30 and should frequently hit 70. During a downtrend, it is rare to see the RSI exceed 70, and the indicator frequently hits 30 or below.

Let’s move to the juicy part of the article and find out how you can use the RSI for day trading.

 

Applying RSI for day trading

Now before you jump to conclusions, it’s important that you know RSI’s ideal settings for day trading.

Most traders like the default RSI value of 14 periods because it causes less market noise.

The RSI analyses data from past trading sessions to determine if an asset is overbought or oversold. When the timeframe of the RSI is reduced, the indicator has less data from which to form conclusions.

As a result, as the periods are reduced, the chart becomes more sensitive.

Increasing the timeframe for RSI, on the other hand, increases the amount of data that is included in the RSI’s calculation. As a result, the data becomes less responsive, and there are less signals on which to make your strategy.

Day traders typically use periods between 9 and 14. So, these are the ideal settings for RSI day trading strategies.

A key point to add here is the RSI settings also depend on your strategy.

 

What are some of the best RSI day trading strategies?

After determining the RSI settings, you now have to apply the indicator as part of your strategy.

So, here are some of the best day trading strategies using the RSI:

RSI Divergences

Divergence is a common method for identifying possible trading opportunities.

RSI divergence happens when the RSI begins to reverse before the price.

A bullish divergence arises when the RSI produces an oversold reading, which is followed by a higher low that corresponds to proportionately lower lows in the price. This means that bullish momentum is building, and a rise above an oversold area could signal the start of a long position.

Conversely, a bearish divergence happens when the RSI creates an overbought reading, followed by a lower high that corresponds to the price’s corresponding higher highs.

As you can see in the following chart, a bullish divergence was identified when the RSI formed higher lows as the price formed lower lows.

 

RSI bullish Divergences

Moving Average Crossover

Moving average crossovers are also used to confirm RSI signals that a market is oversold or overbought. The RSI is frequently used to provide an early indication of potential trend changes.

As a result, using exponential moving averages (EMAs) that respond faster to recent price changes can be beneficial.

Moving average crossovers that are relatively short-term, such as the five EMA crossing over the ten EMA, are most suited to support RSI.

The five EMA crossing from above to below the ten EMA affirms the RSI’s hint of overbought levels and a potential trend reversal.

On the chart below, you can see that when the shorter blue EMA goes above, the longer black EMA, the price goes up. At the same time, the RSI is moving into the overbought territory.

 

RSI and Moving average crossovers

 

Here is also a video that explains the cross over moving average strategy.

 

Can you combine other indicators with the RSI for day trading?

Yes, you can. The example of the RSI Moving Average crossover is proof that you can combine the RSI with other technical indicators.

Another commonly used momentum indicator, the moving average convergence divergence, can be utilized in conjunction with the RSI to help corroborate the validity of RSI signals. 

The MACD evaluates the relationship between two exponential moving averages (EMAs), whereas the RSI measures price movement with respect to recent price highs and lows.

These two indicators are frequently used in conjunction to provide a full technical picture of a market.

 

RSI combined with MACD

 

As you can see, when both indicators go down, we have a sell signal.

Here is a video that shows How to use effectively the MACD divergence strategy

 

Pros of using the RSI for day trading

  • Works best during a trending market condition, combined with moving averages
  •  It is excellent at detecting divergences on the chart
  •  RSI is useful at finding overbought and oversold areas on the chart

Cons

  • RSI is a lagging indicator and can produce false signals
  • It does not contain all of the data necessary for proper analysis of price action, so you should use it in combination with other tools

Summary

The RSI illustrates overbought and oversold levels to determine price movements.

When using the indicator for day trading, you should keep the settings low, as the RSI is prone to false signals.

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