Relative Strength Index (RSI)

Developed by J. Welles Wilder in 1978, The RSI is a wildly used indicator for spotting overbought and oversold levels.

Why should I use it?

As a Forex trader, you always need to know when the price of the market might be trading too high (overbought), or when the price of the market might be trading too low (oversold).
If for example, you bought EURUSD at 1.2500, and the market moved up to 1.2700, it might be that at this price the market is overbought, and at any moment the sellers can jump in and push the price lower. In this case a tool that can indicate when the price is to high, will help you protect your profit by closing the position before the market's direction turns against you.
This is where RSI can help you. It will tell you when the market is possibly trading too high, providing you with the opportunity to sell, or to close any open position you may have on the buy side.
RSI will also tell you when the price of the market is possibly trading too low (oversold), providing you with the opportunity to buy, or to close any open positions you may have on the sell side.

How does it look like?

The RSI indicator is composed out of one line which is drawn under your price chart.
It can have any value between 0 and 100. The values 30 and 70 are key values for the RSI indicator.

How does it work?

The RSI Is very popular mainly because of its simplicity,
The market is trading too high (overbought), when the RSI indicator line is trading above the level 70, signaling you to sell. The higher the RSI is, the more overbought the price becomes.
The market is trading too low (oversold), when the RSI indicator line is trading under the level 30, signaling you to buy. The lower the RSI is, the more oversold the market price is.
The developer of the RSI, Welles Wilder, suggested to set the RSI on 14 periods. This is the default setting on Etoro's platform. However you can definitely experiment with different period settings to find the one best suited for your trading style.
Although the RSI is considered a very efficient indicator, it has one major weakness:
When the market is moving too fast in a short period of time, the RSI will provide false signals; therefore using the RSI in volatile market conditions should always be done with care.

Example

In this example we are observing a USD/CHF chart with the RSI indicator.
At first the RSI is moving under 30 (on Dec 4 around 19:00) indicating the price is oversold and by that creating a buy signal. Later on it is crossing above the level 70, indicating the price is overbought and by that creating a sell signal.