The RSI or Relative Strength Index, was developed by Wells Wilder, and first presented in his book New Concepts in Technical Analysis in 1978. In simple terms, it is designed to identify overbought and oversold conditions in relative terms. The indicator itself ranges between 0 and 100.
A reading above 70 is usually considered overbought and a reading under 30 is considered oversold. However simple this may seem, it can be used in many more ways than simple over bought/sold terms.
Here is what the indicator looks like when a pplied to the currency market. As price approached and moved above 70 or below 30, price usually headed the other direction, but not always. Keep in mind that as with all indicators, they can and will be wrong.

In Wells Wilder’s book he specifically mentions two alternative ways to look at  RSI.
1.    Failure swings
2.    Patterns and formations
Failure Swings
The idea of a failure swing is easy to understand. The best way to describe it is to say that a failure swing happens when a second move fails to reach the same high or low as a previous move. Look at the following example. RSI failed to move as low as it had been on the last low. An entry would take place when the RSI then closes above the high between the two swing lows. This failure swing happens on both the top side and bottom side and signals a possible reversal.

Patterns and Formations
If there is a pattern or formation in price, you can also find the same patterns and formations in the RSI. These include head and shoulders, support and resistance, divergence, channels and more. In his book, Wilder said that, “Divergence is the single most indicative characteristic of the Relative Strength Index.” Let’s take a look at what he meant.

In the previous example the failure swing was also accompanied by some interesting price action. The red candle above the swing failure was also lower than the blue candle above the initial move of the RSI below 30. This is known as divergence. We will be covering it more detail later. The idea though is that price is moving in the opposite direction that the indicator is and they may soon begin moving together.

Here’s another one.

Support and resistance breaks can also be analyzed using the RSI

When back testing with the RIS make sure you don’t limit yourself to just overbought and oversold conditions. The indicator can tell you so much more and with practice you can find more trading opportunities and reduce your exposure to the market as well.

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