How I Like to Use RSI

From all the technical tools at my disposal, one of my most favorite is RSI or Relative Strength Index. It is an index measuring a momentum of a market direction with formula as follows:

RSI=100-(100/(1+RS)) where
RS = Average of x days up closes / Average of x days down closes
So basically, you just have to select parameter of X days to chart the RSI. My favorite parameter for RSI is 20, so I am measuring on daily basis roughly last month of market strength. I also use it with hourly charts with same parameter of 20 which represents almost entire day.

I like to use it as a ‘contrarian’ signal which means going against the prevailing trend. It is because the signal is very decent in identifying tops and bottoms with overbought and oversold lines. For that purpose I select zones when RSI is over 70 for overbought or under 30 for oversold.

The red arrows shows when RSI is over 70 and present overbought zones, and the green ones indicates oversold zones with RSI under 30.
In all those cases I would consider trading it with placing stops below most current lows or above most current highs. That way if the signal proves wrong, and the market continues its trend I am fully protected. Remember that no signal works 100 percent of the time.

If I already have previously established position while tracking RSI, I would certainly like to use it to show me when to take profit, thus getting out of part of my long position when RSI is over 70, and out of my short positions when RSI drops below 30.

A lot of variations can be used here, including different levels of overbought and oversold as well as working with different number of bars. But then, that is for you to figure out what suites you the most.