This article on RSI Trading Strategies is the opinion of Optimus Futures.
There are many ways to use the relative strength index when trading. Traders find different ways to adopt it based on their particular approach. This post covers how to use RSI for swing and day trading.
ALSO READ | The Relative Strength Index (RSI) | An Explainer
RSI Trading Strategies for Swing Traders
If you’ve never used the RSI in a swing trading context, here are a few strategies you can adopt or tweak to fit your style and market.
Like most indicators, the relative strength index strategies differ between time horizons and the trader’s style.
For swing traders, who usually hold positions between a few days and a few weeks, several effective strategies can be used:
Divergence
Divergence is a key pattern that J. Welles Wilder emphasizes in his book New Concepts in Technical Trading Systems.
Given that RSI readings tend to be more reliable with longer-term trends, divergence on the daily charts is more or less ideal for those looking to swing trade the markets.
Divergence gives can give an early signal of a potential reversal in prices. It occurs when the price moves in the opposite direction of the RSI, which translates to a loss of momentum in the move.
There are two types of divergences, a bullish divergenceand a bearish divergence.
- In a bullish divergence, the RSI displays an oversold reading but with a higher low while prices exhibit lower lows.
- In a bearish divergence, the RSI creates an overbought reading followed by a lower high that appears with higher highs in the price.
When trying to use this tool a trader has two potential choices: either take the position when the divergence occurs or wait for the RSI to break out of the overbought or oversold level (whether it is a short or long position) before taking the trade.
The chart below shows the concept of a perfect bullish divergence on the daily chart of the ES (S&P 500 Futures).
While prices hit a new low, the RSI was rising, showing bullish momentum, leading to an eventual bounce in prices.
The trader could’ve taken a long position the moment he saw the divergence or, to be safer, waited for the RSI to break back into neutral territory to initiate his long position. Understanding divergence and RSI tools at an expert level can help traders to identify potential divergence patterns quickly. Divergence trends are not as easy to identify in real time as they are looking back in hindsight.
Failure Swing
A more conservative strategy is called the RSI failure swing.
A failure swing occurs when the oscillator exceeds an overbought or oversold level, corrects back into neutral territory, initiates another attempt to break into the overbought or oversold level, doesn’t reach it, and then turns back beyond the correction.
Let’s take a look at the following ES chart below. In this example, the ES reached a new high between June 22 and August 15h.
The second upswing, however, failed to break above that new high. Meanwhile, the RSI reading began declining from its 70 level.
The trader could have entered a short position with a stop loss above the session’s highs. (“stop-loss” or “stop-limit” orders, will not necessarily limit your losses to the intended amounts since market conditions may make it impossible to execute such orders.) Again, its important to remember looking at these charts we are also afforded the benefit of hindsight. Identifying what should have been done or what is occurring in the market in real time takes practice and years of experience.
Swing traders typically use these tools as two of the most common strategies when using the Relative Strength Index in their analysis.
They’re easy enough to understand and identify, and they’re generally reliable when used correctly.
There are other patterns you can use to swing trade the RSI.
Ultimately, you may want to experiment with the RSI to see if you can develop your own unique approach to using this tool that best suits your strategy and your preferred markets.
READ ALSO | Best Swing Trading Strategies for Futures Traders
RSI Trading Strategies for Day Trading
While the relative strength index (RSI) is typically better suited for long-term and swing traders, day traders and scalpers can also attempt to use this tool; but you will need to adjust the inputs according to your short-term trading environment.
Instead of using a 14-period RSI, you might want to choose a lower period of between 6 and 9 for trending markets and between 3 and 5 for ranging markets to generate more actionable overbought and oversold signals. Selecting the correct period is important when utilizing RSI.
The RSI Strategy for Scalpers
Trading with RSI involves a well-rounded strategy, which is especially important for scalpers.
For day traders who execute quick in-and-out trades with tiny profit margins, relying only on RSI can be sometimes misleading. As noted above it can be difficult to spot patterns or divergence trends in real time. Shorter time frames make using this tool more difficult and less reliable.
Overbought and oversold levels indicated by RSI can continue for long periods, forcing scalpers into multiple entries into the market.
This can result in minor gains while increasing the possibility of larger losses.
A comprehensive day trading strategy that considers factors such as overbought and oversold conditions, buy and sell signals, and price movements is important for traders to implement to increase their chances of success potentially.
A day trading strategy should also take into account the limits of RSI and use additional tools and analysis to have a complete understanding of market dynamics.
Source: Optimus Flow
A Combined MA and RSI Trend Scalping Strategy
Another scalping strategy involves using moving averages to determine the trend and then taking a position based on the RSI. This is a more traditional approach to using the RSI.
In this case, you might want to use a longer-term moving average, such as a 100-period MA, to determine the trend.
In this strategy, you would take only long positions when the moving average is trending upward and short positions when the average is trending downward.
The long position is taken when the RSI approaches the 30 level, and the short position is taken when the indicator approaches or touches the 70 level.
Note in the micro gold futures chart below there were several opportunities to go short between 11.15.22 and 11.17.22 once the downtrend has been confirmed using the 100-period MA. Again remember that it is much easier to identify these opportunities with the benefit of hindsight.
The arrow points to potential short selling entries based on the price breaking above or touching the RSI 70 level during a short-term downtrend.
Source: Optimus Flow
The Bottom Line
The RSI wasn’t designed for day trading or scalping. But this doesn’t mean that a short-term trader can’t tweak the tool to make it useful for either trading style.
Remember, finding an “edge” often means developing perspectives, tools, and approaches that most traders do not commonly use. Edge in the market comes from doing things different from everyone else. Practice with different tools on historical charts outside of actual market hours. Once you determine your testing will be useful to your actual trading strategy then start slowly trying out your ideas. Trading is very much a game of practice as well as trial and error.
In conclusion, we can see that all indicators can be used in any time frame or context if you can figure out a way to adjust the parameters to match your trading style and the demands of the market environment.
There is a substantial risk of loss in futures trading. Past performance is not indicative of future results. Charting presentations and scenarios are presented as examples only and were prepared with the benefit of hindsight.
