What is RSI Overbought and why is it important for trading

RSI Overbought is a condition in which the price of an asset is overbought and the Relative Strength Index is above the 70 level. This is the basic knowledge that traders need to understand to avoid buying too expensive. In this article, we will explore how the RSI is used to classify overbought oversold conditions and its application in different trading strategies.

What is the RSI (Relative Strength Index) indicator that measures?

The Relative Strength Index, or RSI, is an indicator developed to measure the strength of buying and selling power within a given period. By comparing the ratio of price increases and decreases.

RSI is calculated from the formula RSI = 100 - (100 / 1 + RS) The RSI is the ratio between the average price increase and the average price decline over an N day period, the resulting value is in the range of 0 to 100, which makes the RSI easy to read and interpret.

This indicator allows traders to:

• Identify the points where the price may reverse.
• Measure the momentum of price movements.
• Confirm the strength of the trend.

Overbought and Oversold conditions in view of RSI

The RSI measures overbought oversold conditions in two ways, which is another benefit that makes the RSI a widely used indicator.

Overbought Condition (RSI > 70)

When the RSI is overbought, it means that the asset is being bought with high confidence. Prices are rising rapidly, and it’s likely that prices may be too high. During this period, Traders should be wary of further buying as there is a high risk of the price falling or entering a stagnation phase.

Oversold Condition (RSI < 30)

When the RSI is below 30, it indicates that the asset is being oversold. The price fell sharply and may rebound. Oversold signals often indicate that the previous selling pressure is starting to wear out and buying is about to take its place.

It is important to note that values of 70 and 30 are the most commonly used standard levels, but they can be adjusted according to the characteristics of each asset, for example, some may use 75 and 35 or 80 and 20 as appropriate.

Stochastic Oscillator vs RSI, which is more suitable?

In addition to the RSI, there is another indicator that is used to indicate overbought oversold conditions: the Stochastic Oscillator, which uses a different methodology.

Method of Stochastic Oscillator

Stochastic measures the position of the closing price relative to the range between the highest and lowest prices over a 14-day period.

%K = [(Closing Price – 14-Day Low) / (14-Day High – 14-Day Low)] × 100

%D = Average %K of the past 3 days

Stochastic has values ranging from 0-100, as well as RSI, but the calculation method is different:

• %K > 80 indicates an overbought condition.
• %K < 20 บ่งชี้ภาวะ Oversold

Comparison between RSI and Stochastic

As a result of this difference, the RSI is suitable for catching strong trends, while the Stochastic is suitable for markets that do not have a clear direction (sideways).

Trade the Divergence with the RSI to catch the trend reversal point.

Divergence is one of the most effective strategies when using the RSI in trading.

Bullish Divergence

It occurs when the price makes a new low (lower low) but the RSI does not make a new low (higher low) instead.

Bearish Divergence

It occurs when the price makes a new high (Higher High) but the RSI does not follow it to a new (Lower High) instead.

Example of trading Divergence with RSI

1. Observe the price of an asset with a clear trend, such as WTI, which has been declining continuously.
2. Observe the RSI approaching the Oversold zone with a Bullish Divergence signal
3. When the brake price breaks through the MA25 and above. This is the entry point for buying.
4. Set the stop loss at the previous low and cut the loss if the trend breaks

Mean Reversal for Sideway Market with RSI

Mean Reversal is a strategy that assumes that the highs and lows that occur are temporary events and that the price is likely to pull back towards the average.

Mean Reversal Strategy with RSI

1. Use the MA200 to identify the trend. Shows an uptrend If it is lower than Shows a downtrend
2. Optimize the RSI, e.g. use Overbought at 75 and Oversold at 35 for an uptrend.
3. Buy when the RSI touches the oversold zone (35) in an uptrend.
4. Close the position when the price re-enters the MA25 or when the RSI enters the Overbought zone.

Example of the USDJPY currency pair on the 2H scale

During USDJPY, there is a clear uptrend:

• The price jumps above the MA200 line and pulls down to test again.
• MA200 can be used as a strong support
• Set the RSI Overbought value at 75 (weaker than the standard value) due to the uptrend.
• Set Oversold value at 35
• Use a buy strategy mainly at the oversold point Avoid overbought sales
• Close the position when the price returns to the MA25 or if the price breaks the MA200 line down.

This strategy works well when the market swings sideways, whether it is a light uptrend or a light downtrend.

Precautions and Summary Using RSI in Trading

The RSI is a valuable tool for identifying potential price corrections, but it should not be used alone.

CAUTION:

• RSI Overbought does not mean that the price must fall immediately. In a strong uptrend, the RSI may stay in the overbought zone for an extended period of time.
• False signals are common, especially in highly volatile markets.
• The RSI must be used in conjunction with other indicators such as Moving Average, Divergence, or Price Patterns.
• Adjust the Overbought/Oversold value to suit the asset being traded.

Conclusion

The RSI is an indicator that allows traders to systematically identify overbought oversold conditions. When the RSI is applied to strategies such as Divergence or Mean Reversal and combined with other analytical tools, it can help your trading system become more accurate. However, it is important to remember that no indicator is 100% accurate, so risk management and confirming signals from multiple sources are the most important in successful trading.