The most common way to trade with it is by looking at overbought and oversold areas.
You buy when RSI says oversold and you sell when it says overbought. This approach is trading against the market trend and therefore it is possible that you will be wrong often.
With RSI overbought and oversold levels there are two typical ways how to get a confirmation that the market is likely to go in your direction: Wait until RSI reverses. Wait until RSI leaves the oversold or overbought area and returns to the neutral area.
When the RSI shows an oversold market e. Then RSI reverses and rises from 5 to It tells you that the market might not be so bearish any more — the bears have definitely lost some power on this last bar.
So when the RSI fails to make a new low and instead rises from 5 to 12 you consider it a sign of a possible reversal and buy. This is an example of the first one of the overbought option points above wait until RSI reverses.
When RSI rises from 5 to 12, you see that it is still below the oversold borderline and therefore still consider it too dangerous to bet against the still heavily bearish mood.
Then on the next bar the RSI rises from 12 to 22, leaves the oversold area and returns to the neutral area between 20 and This is the sign that the bearish momentum has faded and you buy the market.
Is Waiting for Confirmation Worth It? By waiting for confirmation you filter out some situations when the market overbought option makes a small correction and then continues in the original trend which you intended to bet against.
Of course there will still be situations when RSI comes back to the neutral area, only overbought option return to oversold on the next bar and you lose anyway.
But in the long run you can improve your winning percentage in this way. The cost is that you usually give up a piece of potential profit, as you are entering after the market has gone a bit in your direction already.
- Overbought vs Oversold: A Trader’s Guide | IG EN
- RSI Overbought and Oversold Condition - Macroption
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Is it worth it? Sometimes — that is up to your research and your own trading to figure out.
Updated Oct 19, What is Overbought? Overbought is a term used when a security is believed to be trading at a level above its intrinsic or fair value.