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Forex scalping is a trading strategy that is designed to capitalise on small price fluctuations between currencies traded on the Foreign Exchange markets. To maximise potential gains, identifying optimal entry and exit points is essential to ensure that nothing is left behind.
To assist in identifying trading opportunities, traders will use a variety of technical indicators within their strategy. This guide discusses the Relative Strength Index and the pro's and con's of its inclusion into a RSI scalping strategy.
In This Article:
- Overview Of A Forex Scalping Strategy
- What Is The RSI Indicator
- Using RSI Indicator In A Scalping Strategy
- Limitations Of RSI Scalping
- Summary
Overview Of A Forex Scalping Strategy
Before we begin discussing the RSI scalping strategy, we must first understand the basic principles of a Forex scalping.
A Forex scalping trading strategy is the process of identifying several trading opportunities per trading session, focusing on the smallest time frames and holding positions for very short periods of time prior to closing. The trading style is best suited to traders that are able to dedicate sufficient time to consistently monitor currency markets and quickly identify optimal entry and exit points.
Forex scalping requires the implementation of a considered and well written trading strategy that defines which market conditions must be met prior to entering a trade. This assists with being able to react quickly and enter a trading position when trading conditions are perfect. The individual trader must trade with discipline to ensure that the scalping strategy is implemented correctly.
The criteria set out in the trading strategy will depend entirely on the individual. Some traders will rely solely on technical analysis and patiently wait until the trading signals are met, reacting immediately on the signals provided by their chosen technical indicators, this guide focuses on the RSI. Others will depend more heavily on fundamental analysis and trade the volatility that follows an important economic announcement.
Whichever method of identifying a trading opportunity is used, the common element is that trades are held for a short amount of time, taking advantage of gains that can be as small as a few pips. Once the required targets have been reached, the trade is closed with no thought of holding onto the position. The desired outcome is to accumulate a large number of small gains.
» For more information on what should be included within a strategy, see our guide writing the best Forex scalping strategy.
What Is The RSI Indicator
The Relative Strength Index (RSI) is a popular technical analysis tool that is used in Forex analysis. It is designed to provide an indication of momentum in the market place by measuring speed and change of price movements to provide the user with over or under valued price of a chosen currency pair.
The RSI is a simple oscillator that can provide useful information that assists a trader in pinpointing an entry point for a trading position, and just as importantly, a signal to exit the trade.
The RSI indicator is generally set to provide an overbought signal if the reading is above 70 and an oversold signal if the reading is below 30. These parameters can easily be tailored by the user to suit their risk appetite. The overbought signal could be set to 80, providing more certainty that the currency is overbought. Equally the oversold signal could be reduced to 20.
Adjusting the parameters to more conservative levels may provide more certainty on forthcoming price movements, but it will reduce trading opportunities.
Using RSI Indicators In A Scalping Strategy
To implement the RSI scalping strategy, it is necessary to first identify the longer term price trend.
» For more information on identifying a trend see our guide how to draw a trend line.
» For more on why trading the trend is important see trend trading for a proven strategy.
There are three types of trend price trends and the RSI scalping strategy can be used in all of them:
Bullish Trend
A bullish trend is shown when prices are trending in an upward direction. Scalping using the RSI indicator involves taking trades when prices have fallen and an oversold reading is being provided by the RSI. As the oversold signal is generated, a long position is entered inline with the longer tern bullish price movement.
Bearish Trend
A bearish price trend occurs when prices of a currency pair trend downwards. This as you would expect is the opposite trading activity that would occur within a bullish market. As prices have temporarily risen and an overbought signal generated by the RSI, a short position is taken in the expectation that prices will revert back in line with the longer term down trend.
Sideways
Sideways price trends occur when there is neither a clear bull or bear trend and prices oscillate between levels of support and resistance.
We can see from the above EUR/GBP 1min technical chart that prices are clearly moving in a sideways position and within a range. The RSI indicators is shown below the price chart and we have highlighted several trading opportunities, red arrows for short positions when the RSI indicator is showing overbought and green arrows for long positions when the RSI indicator is showing oversold.
The RSI scalping strategy can be used in all three market conditions but works most effectively during a period of sideways movement.
Limitations Of RSI Scalping
The RSI indicator is a measure of momentum and is not to be taken as a guarantee of signal of a price reversal. It is important to remember that although and overbought reading may be in play, it does not necessarily mean that buying pressure won't continue. An overbought or oversold signal can span many time frames, it is therefore important that a trading position is protected by placing a stop loss order in line with risk to rewards ratio's set out in your trading strategy.
» For more information on risk reward ratio's see our guide risk reward ratio's when Forex trading.
Summary
The Relative Strength Index is a useful technical indicator, used to identify overbought and oversold markets to trade in an RSI scalping strategy. The RSI indicator can be used in all market conditions, regardless of underlying trend direction, although it is widely regarded to most suitable to a sideways trending market, particularly if there are clear points of support and resistance.
The RSI indicator is no guarantee that prices will swing when overbought or oversold reading are provided, it is necessary to place a stop loss order in line with a trading strategy to protect against a pro-longed period of trading momentum in either direction.
