Relative Strength Index

Relative Strength Index (RSI) is an extremely useful and one of the most popular momentum indicators in the Forex technical analysis. Its value moves between 0 and 100 so is an oscillator. Welles Wilder introduced it for the first time in June 1978 and most often is used by day traders and other short term investors.
RSI measures momentum and indicates if a currency is currently "overbought" or "oversold".

If the currency’s price is increasing, RSI will move upwards closing to 100, suggesting buying or accumulation of the currency pair.If the price is decreasing, RSI will move downwards going closer to 0 and indicates selling pressure or distribution.

At first RSI’s default period was 14-days but now the 9-day and 25-day period are also very common. The fewer days used for its calculation, the more volatile is the indicator.

The basic formula used for RSI is:

RSI = 100 – 100 / (1 + RS)

Where RS = Average of x days' up closes / Average of x days' down closes

In order to account for all past data you need to smooth the RS using the next formula:

RS = [(previous Average Gain) x 13 + current Gain] / 14
         [(previous Average Loss) x 13 + current Loss] / 14

Where the period used is 14-days;
First Average Gain = Total of Gains during past 14 periods / 14;
First Average Loss = Total of Losses during past 14 periods / 14;
"Losses" are reported as positive values.

In the analysis you must be careful because a very large up or down movement in price in a single day can produce a false signal.

The centerline of the RSI is 50. When the centerline is crossed over can confirm bullish or bearish symbols coming from other indicators and to validate signals from RSI overbought/oversold levels. A value above 50 suggests the currency is in a bullish phase as average gains are greater than average losses. Readings below 50 indicate a bearish phase of the currency. Wilder set the levels at which currencies are overextended at 70 for overbought and 30 for oversold.

Divergences can indicate reversals so you must pay more attention to them. When the currency pair is making new highs but the RSI does not surpass its previous highs appears a Negative (bearish) Divergence. If currency’s price is new lows but RSI fails to surpass its previous low occurs a Positive (Bullish) Divergence.

Looking at the way market responds to the RSI value approaching to 70 or 30 levels a good trader can identify levels of support and resistance. Although RSI is a very good indicator it must not be used alone in the Forex technical analysis. All decisions in Forex trading should be taken after a deep and thorough analysis of the market.