Basic Tools to trade currencies

RELATIVE STRENGTH INDEX(RSI)Basic currency indicator 1

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RSI (Relative Strength Index).This is a very useful indicator to know over bought and over slod conditions. You need not have to worry about the calculations for all the charts come with this indicator. Main uses of this indicator.

1  Tops and bottoms. These are indicated when the reading goes above 70 (top) and below 30 (bottom).

2  Chart Formations. The RSI may form chart farmations that may or may not appear on the actual chart. eg. You might see a head and shoulder formation on the RSI but not on the candle stick chart.

3  Failure swings. When the RSI goes above 70 or below 30 this is a strong indication that the market is ready for a reversal.

4  Support and Resistance. It is sometimes more apparent that support and resistance is forming in the RSI than can be seen on the candlestick chart.

5  Divergence. When price makes a new high or low and this is not confirmed by RSI, this can be very strong indication that the reversal is imminent.

Use of divergence in designing a trading system. The market is in an uptrend for quite some time.You think the market is topping.You see a divergence, then you are lot more confident that it has in fact topped. Warning.Don't use RSI as a sole trigger for a new position rather use it in combination with other patterns/indicators ect to help build a picture.

RSI is a momentum oscillator that compares the magnitude of gains against the magnitude of losses.This is developed by Wilder.

Over bought and oversold condition. RSI rises above 30 is considered bullish.RSI falls below 70 is considered bearish.

Divergences.Positive divergence and negative divergence.Divergences that occur after an overbought and oversold reading usually provide more reliable signals. 

Central Line cross over. Centre line for RSI is 50.Reading above 50 is bullish and below 50 is bearish.On the whole a reading above 50 indicates that average gains are higher than average lossess and readings below 50 indicates that lossers are winning the battle.A swing trader prefers 14 periods.

Banded oscillators.Banded oscillators fluctuate above and beow two bands that signify extreme price levels.The RSI is rangebound by 0 and 100.

SIGNALS

Positive and negative divergences. Divergences can serve as a warning that trend is about to change OR set up a buy or sell signal.

Overbought and oversold extremes. Banded oscillators are best used in  trading ranges OR with securities that are not trending.

In strong trend users may see many signals that are not valid.If a security is in strong uptrend buying in oversold conditions (near support tests) will work much better than selling on overbought conditions.During a strong down trend selling when osillators reach overbought conditions(near resistance tests) would work much better.If the least resistance is UP then acting on only bullish signals would be in harmony with the trend. If the least resistance is DOWN then acting on only bearish signals would be in harmony with the trend.Attempt to trade against the trend carry added risks.

When trend is strong banded oscillators can remain near overbought or oversold levels for extended periods.A negative divergence form, but a bearish signal against the uptrend should be considered suspect.This does not mean counter-trend signals won't work but they should be viewed in proper context and considered with other aspects of technical analysis.Identification of an overbought or oversold condition should serve as an alert to monitor other technical aspects(Price, pattern,trend,support, resistance,candlesticks,volume or other indicators) with extra vigilance.Simple signals can be combined with divergences and moving average cross overs to create more robust signals.

    CONDITIONS                                                              CONDITIONS

1)    Oversold                                                              Overbought

2)    Positive divergence                                        Negative divergence

3)   A cross above 30                                             A cross below 70

A    TRADING RANGE                                             TRADING RANGE

B     UPTREND                                                              DOWN TREND

WORKS BEST                                                                WORKS BEST

RSI used for 1) Trend analysis  2) To help determine price objectives.

Determining the RSI range. 1) An uptrending market will typically find support at the 40 level with effective resistance at 80 level        2)A down trending market will find resistance at 60 level with effective support at 20 level.

Often times a primary indication that the trend has shifted from the bear trend to a possible bull market occurs when the RSI which previously was respecting 60 level rallies up to 70 or higher.When the inevitable decline arrives the RSI will respect the 40 level before rallying again.

In 80/40 range bull market you will see the RSI make higher tops and higher bottoms, a classical indication of bull market.Likewise in a 60/20 range(bear market) you will see the RSI making lower bottoms and lower tops.Recognising the RSI behaviour is very useful when first looking at the chart of  commodity, currency or stock.Inspecting the range the RSI is in, is the first clue indicating the trend.The RSI will also find Resistance or Support  at previous tops or bottoms in the RSI values themselves.Old risitance points could become new resistance points and if broken a new support level upon retracement.Likewise old support levels could prove to be effective support again, and if broken will prove to be effecive resitance.

Determining support and resistance levels.

Looking for divergences.                                                                                        Bullish Divergence.(Bottom failure swing).RSI below 30 and fails to make a new low.When RSI proceeds to exeed the previous  RSI peak, a short term buy signal occurs.

Bearish Divergence.(Top failure swing).RSI over 70 and fails to make a new high.When the RSI proceeds to exeed the previous RSI low,a short term sell signal occurs.

80 is highly overbought and 20 is highly oversold. 

RSI for determining break-outs.

Two general conditions  1) Range bound  2) Trending.A range bound market tends to remain between defined support and resistance levels and fails to trade to new highs or new lows.A trending market on the other hand tends to trade to new highs and new lows and may extend for a significant period of time.

As the market approaches a significant high we may either decide to sell anticipating the range to continue or buy anticipating a break-out.

In fact on forex where volume data is usually not available the RSI  can be used as a proxy for volume with large upward spikes in RSI indicating strong buying.

Range bound markets.

1) Buy as the RSI dips below 30 and crossess back above it.                2)Sell as the RSI rises above 70 and crossess back below it.

Break-outs.

1) Price break resistance and trades to new high .                                      2)RSI crossess above 70.                                                                                        Hence if we have an indication of a break-out we should look for confirmation not only on the RSI but also in the price action.If the RSI breaks above 70 and market price fails to break above a resistance level indicates that the current range will tend to continue. However if the market price trades to new highs breaking a previous resistance level as the RSI crossess above 70 a  new trend or a continuation of the trend to the upside is strongly indicated.Trading these simple horizontal trend line breaks, which denote support and resistance provide us with high probabiity set-ups.

Conditions.

1)RSI breaks a previous swing high to rise above 70.                                     Price also breaks a resistance level.                                                                   Price should continue with the uptrend.                                                      2)RSI breaks a swing low to drop below 30.                                                      But price does not cross the support level shows price will not continue the down trend.