Does the RSI work?

RSI indicator stock market

The Relative Strength Index (RSI) is one of the best known and most used in the world of short-term trading.

This indicator was introduced by Welles Wilder in 1978 in an article of the magazine “Commodities”, today known as “Futures”.

The relative strength does not refer to two different assets but to the same one, where the index tries to guess what areas are overbought or oversold.

Basically, this index is a contrarian one, which is looking for changes of trend.

In general, the index should behave well in lateral markets and bad in trendy ones.

When Wilder introduced the indicator he recommended a 14 days period.

However, as time went by people have been using their own periods, being able to find infinite variables and even an RSI for scalping in trades which last minutes.

indicator Relative Strenth index
As we can see this 14 periods RSI did not work very well in a lateral market for a 15 minutes bar chart in the EURUSD. Imagine a trending market.

RSI trading

The RSI is an indicator that moves between two values: 0 and 100, but in which traders usually look for the range 30/70 to determine the points over which the market is overbought or oversold.

In other words, in 70 the market should be “expensive” and in 30 should be “cheap”.

The example says that when the price touches or goes beyond one of those extremes and come back then we get a signal to buy or sell, supposedly.

For example, imagine that the indicator goes above 70 until 80 and when it comes back to 70 and crosses it the market should be considered about to have a reversal after being overbought and logically we should sell.

The bad part about this is that the indicator can also gives us false signals.

Winning in trading is not that easy folks.

RSI automated trading

One of the main uses given to this indicator if for automated trading since with a simple algorithm there are many possibilities of determine different points of opening and closing trades.

This is one of the most popular indicators for this type of automated trading trying to do day trading or scalping in the Forex markets.

It is used so much in the Forex automated markets because this market permits the automation of strategies to the retail traders in a very easy way through the platform Metatrader 4.

This indicator usually gives good results in the short-term but fails to deliver in the long run.

RSI charts

The main problem of this indicator is that it will tend to work well in lateral markets and bad in trendy ones.

People think that as markets are supposedly not moving 75% of the time, using strategies that go well in lateral markets is a good idea.

This is a wrong idea because the market is actually moving much more than 25% of the time.

It is possible that the great movements happen all the time, but the 75% of the time that the markets are supposedly not moving, in fact they are moving quite a lot.

We can have many attempts of rising or falling but we will never have a completely non moving market during 75% of the time, at least not in a perfect way.

If it was like that it would be too easy to make money.

However, having success in short-term trading is not that simple, I would say almost impossible in the short time frames like those of day trading.

In general, my advice is not to lose time with these indicators that only contribute to create confusion to us, especially when they are used in conjunction with other indicators.

They can be beautiful in the graph, giving us the impression that they have some sort of sophistication, but the truth is that it is nothing more than an illusion.

Regarding automated trading, it does not matter if we try this indicator along with other, but we should not get carried away because we have some positive backtests. Those backtests might not work the same in real conditions.

That is why if someone has good results using historical data it would be good to apply them in a real market, with small money and for a long time.

A hint: a particular case where this indicator could give good signals would be that of trying to buy a market when there would be oversold signals in a RSI of a daily chart and always with stocks with a strong bullish trend.

Although if you have enough experience you do not really need this indicator to see the market is clearly trending upwards.

Original article: ¿Funciona el indicador RSI?

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