During our live webinars each day, one of the key areas about which traders have questions is how to interpret Overbought and Oversold areas on indicators such as the RSI and Stochastis.

Let's use the RSI for our explanation&Above 70 is overbought territory according to the RSI but being over 70 does not mean that it cannot become even more overbought. Many new traders will short as soon as the RSI goes above 70 or buy when it is oversold below 30 and then they get stopped out as the pair continues to move against them.With the RSI, think of a thermostat for setting room temperature that tops out at 90 degrees...won't show any higher temperature than that. Even though the thermostat reads 90 degrees, the actual room temp could be 110 or 120 degrees. (Keep in mind that I live in Texas!)So, even though a pair is in overbought/oversold territory, it can still continue to move in that direction without affecting the numeric value of the indicator.The key is waiting for the pair to move below 70 in a downtrend or above 30 in an uptrend after having closed above or below those levels.Keep in mind as well, that a trader would want to be using the RSI, or any other indicator for that matter, in conjunction with price charts and combine the input they would receive from both the chart and the indicator prior to making trading decisions.

In other words, only take signals from the indicator that signal taking a trade in the direction of the Daily trend as that will be the higher probability entry.

Richard Krivo contributes to the Instructor Trading Tips articles. To receive more timely notifications on his reports, email rkrivo@fxcm.com to be added to the distribution list.

Related Articles
  1. Forex Education

    Four Currencies Under the Spotlight in 2016

    With currencies having become the “tail that wags the dog,” in terms of their impact on the global economy, these four currencies will be under the spotlight in 2016.
  2. Forex Fundamentals

    These Currencies Are The Biggest Losers Of The Stock Downturn

    Here’s a list of the hardest-hit currencies amid the global stock market mayhem.
  3. Forex Strategies

    Will the Euro Continue to Rally? (EUO)

    The euro is rallying. Should investors chase this performance or is the real opportunity on the other side of the trade?
  4. Investing News

    China’s Forex Reserves Dropped Significantly

    China’s forex​ reserves dropped by a record $93.9 billion at the end of August to $3.56 trillion because the Central Bank has been selling dollars to provide a cushion to the falling yuan​
  5. Forex

    The Pros and Cons of a Fully Convertible Rupee

    Amid the rising economic power of India, the talks of making the Indian currency fully convertible are gaining momentum. We look at the pros and cons.
  6. Forex Fundamentals

    Chinese Yuan an Unlikely Reserve Currency

    As the world's second largest economy, China's challenge to America’s dominance includes a push to make the yuan (RMB), the world’s reserve currency. Whether it can do that now is unclear.
  7. Economics

    How Currency Enforcement Helped Sink The Trans-Pacific Partnership (TTP)

    One particular barrier to trade that has received much attention of late and caused delays in negotiations of the TPP is exchange-rate manipulation, by which a country artificially devalues its ...
  8. Forex

    Top U.S Forex News Sites

    Breaking news moves forex markets. Here are the top U.S. sites for tracking forex news.
  9. Investing

    Financial News Comparison: Bloomberg Vs. Reuters (BAC, GOOG)

    Access to financial information has grown with the expansion of digital news. Bloomberg and Thomson Reuters lead the pack, claiming a majority of the business information market.
  10. Economics

    Who Benefits From South Korea's Lowered Interest Rates?

    South Korea is the latest country to cut interest rates in an attempt to stimulate economic growth.
Hot Definitions
  1. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  2. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  3. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  4. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
  5. Flight To Quality

    The action of investors moving their capital away from riskier investments to the safest possible investment vehicles. This ...
  6. Discouraged Worker

    A person who is eligible for employment and is able to work, but is currently unemployed and has not attempted to find employment ...
Trading Center