RSI confirmation forex trading strategy

The relative strength Index is a powerful tool used by forex traders to determine if current prices can be justified and in order predict future price reversals. As a momentum indicator, it has pre-emptive qualities and can be considered more useful than lagging indicators, such as moving averages, due to the fact that they can consistently indicate the future direction of price. Used correctly, a strategy including the RSI will provide powerful signals of when a great trade may be approaching. However, it is important to use all indicators alongside additional confirmation in order to ensure the best timing of a trade. This strategy combines both the RSI and candlestick analysis in providing excellent forex trading signals.

RSI divergence

Perhaps the most powerful trading signal provided by the RSI indicator is divergence. Divergence occurs when the RSI indicator disagrees with the current price at a point when a recent low or high is made by the currency pair. The significance of the RSI showing a lower high, for example, whilst the price charts shows a higher-high can be considered as an indication that the momentum in the market is fundamentally weaker than the price chart would suggest. Looking historically back over any currency price chart and any timeframe, this divergence occurs frequently and very often precedes a reversal following this. However, divergence alone cannot provide a trading signal due to the fact that any reversal may not always be immediate or guaranteed. Forex traders can take this as a signal to confirm the direction of a trade and to begin to look for reversal trade opportunities in order to confirm the divergence signal.

Confirming RSI divergence alongside candlestick analysis

Confirming a trade with the RSI divergence trading strategy requires additional confirmation for a valid trade set-up to be formed. An analysis of the price-action, such as candlestick patterns, are often used as a standalone trading strategy by many forex traders. However, applying this to a currency pair when divergence has occurred on any timeframe can provide a high-probability reinforcement of the divergence trade.  Candlestick reversal patterns such as shooting stars, engulfing candles and inside bars all provide a high probability of a trade reversal. The occurrence of these patterns following divergence in the RSI can be considered an opportunity for a profitable reversal trade.

Increase the probability of success with key levels of support and resistance

An additional analysis which can be applied to this strategy is the application of key levels of support and resistance to a price chart. These zones, where price has previously reversed, or where key pivot points and round numbers exist are excellent places for RSI divergence trades to successfully occur. Historical zones of support and resistance require significantly more momentum to be broken and therefore the occurrence of divergence and reinforcing price-action at these levels will have a high likelihood that the support and resistance levels will be maintained, at least in the short-term.