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Many traders including experts do not understand RSI, the Relative Strength Index.

I often ask experienced traders about their trading methods in particular in regard to how they might use indicators in trading.

I ask this question because I have found the use of RSI as a significant help to creating profits in trading Forex as well as commodities, bonds, equities, and indexes.

One answer I get a lot is, No, I don’t use indicators. I only use price. This is too bad as you will see.

The other answer is more along the lines of Yes, but only to confirm my trade. On the face of it this seems to make sense but looking closer why would you use something to confirm a trade when it is not of prime importance?

Trading analyst almost invariably invoke this phrase, “Looking at the momentum indicators, the trade is overbought (or oversold)…” You read this on websites and you hear it on CNBC so it must be true. But nothing is further from the truth.

Overbought and Oversold are relative terms that have no meaning in regard to momentum indicators, in fact, it can be shown that RSI needs to move to the lowest RSI levels (considered oversold) to begin a downward trend, just the opposite of what an analyst would say. And vice versa for an uptrend. These are called Range Shifts.

This is even more interesting when you consider that RSI is one of the most used momentum indicators. Typical RSI rules are; sell at 70 RSI and buy at 30 RSI. Seventy RSI is overbought and 30 RSI is oversold. This of course is wrong. If you used those as signals you would blow your account very soon.

Every trader who uses RSI, or wished to, needs to understand that there are 4 main trading signals on RSI:

* Negative (Bearish) Divergence
* Positive (Bullish) Divergence
* Negative (Bearish) Reversal
* Positive (Bullish) Reversal

My research has shown some very revealing things about these signals. For example, in a down trending market you would only want to trade Negative Reversals and Positive Divergences.

If you traded Negative Divergences, also a downward signal, you would lose money. That’s because Negative Divergence is a retracement signal for Positive Reversals in an up trending market.

The proof of course is in the pudding so it is said. So here is some real data that will show the contrast of how these signals work.

A trader trading using each of the above signals in the first half of 2010 would have seen the following results in pips profit.

* Negative (Bearish) Divergence (-204 pips on 32 trades)
* Positive (Bullish) Divergence (5,761 pips on 91 trades)
* Negative (Bearish) Reversal (14,734 pips on 164 trades)
* Positive (Bullish) Reversal (-5418 pips on 135 trade)

Those are phenomenal differences and show the distinct value of knowing each kind of trade signal that RSI produces and which to trade in current market conditions.

To become a better trader learn the correct principles of how to trade RSI and you will see you profits begin to grow.
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Ihab Salloum