There are 4 trading signals associated with RSI; positive and negative divergence and positive and negative reversals. In a 9 ½ year study beginning in 2000 there were 6702 reversal signals on the EURUSD hourly charts averaging over 70 pips per trade. This is significant information because it shows that the RSI indicator (Relative Strength Index) is a viable Forex standalone trading system.
The reason RSI works as a standalone system is that RSI measures 2 kinds of momentum and uses a 3rd kind of momentum to enter the market.
Momentum type number one
The first type of momentum is measured in RSI when price is being slowed down in a trending situation. For example if prices are moving downward there would are two kinds of signals that would predominate on RSI charts; positive divergence and negative reversals. For traders who have traded divergences before on RSI or other momentum indicators this is probably the opposite of what they were doing as a positive divergence would indicate that prices were reversing to the upside. This however is exactly opposite. Positive divergences in downtrends lead to reversal signals that move the market downward. This is momentum then that is slowing the market from moving down too fast or in an uptrend it is the momentum that is slowing price from moving upward too fast.
Momentum type number two
After momentum type number one is completed momentum type number two take over. It is the force that typically alerts traders to the fact that the market is actually getting ready to reverse from a retracement and rejoin the trend again. These are reversal signals and as indicated in the introduction they are the signals that are the money makers for traders who use RSI. These signals are the key alert signals that Forex traders look for and the signal that creates the “possibility” of a trade.
Momentum type number three
This is the momentum that few traders understand or know how to utilize and makes the difference between an average trader and a profitable trader. In all of the research that I have done, I have never come across this concept, not once.
Were you to Google this topic you would not find it. The momentum that I am talking about comes at certain times in the market and typically is combined with a reversal signal. It occurs during the peak trading hours but should not be confused with volatility. In the best of times, it is post economic news.
Traders who understand this momentum know whether to trade with it or against it. With the trade comes with an entry at a momentum-time-high and the other, against it, is an order flow trade which uses momentum in a backhanded sort of way and can be in the momentum-time-high or outside of the momentum-time-high. The most sophisticated trade is when the RSI trader catches both sides of the trade with and against.
RSI is the perfect standalone trading system that trains you to read charts by understanding the 4 RSI trading signals and also to understand the 3 kinds of trading momentum. Once these simple concepts are understood, the Forex trader is on their way to understanding the concepts behind trading for profits on a consistent basis.
Source by Paul W. Dean