This is a question that every trader wants to skip to. What is the secret sauce? Well, the truth is that those who have discovered a secret sauce probably won’t tell you, it’s a risk to do so. That is one of the reasons why Candleverse exists. It’s to help uncover their secrets or help you create your own.

When you are crafting your trading strategy and deciding how to use RSI, it is important to remember trading is a game. It’s you against every other trader, including the traders with secret sauce. When you have a winning trade, it means there is a trader losing on the other side.

To win, you need to understand your opponents. What strategies are they using and how do I counter them. If you are losing, they are winning. It means the buyers are one step ahead. They are buying when you are selling and selling when you are buying. How do they know? They know because they started here with learning how to read the market and create a trading strategy.

So, how do you use RSI to win.

In RSI 101, we discussed some options:

Overbought and oversold

Bullish and bearish divergences

Breakouts and breakdowns

Before I dig deeper into the trading ideas I want to preface it with just how many trading strategies exist and why secret sauce is attainable.

There are 5 key variables that impact how you might want to use RSI or any indicator in your trading strategy. It is important to understand how these interact with the indicator you want to use in order to be successful.

Are you entering or exiting a trade?

What interval are you trading on?

What tickers are you trading?

Are you using other indicators to help make your decision?

How long are you planning on being in an active trade?

Every trading idea can be impacted by what your variables are. For example, it might be profitable to use a RSI overbought weekly candle in combination with a MACD indicator value as your entry and it might also be profitable to use an RSI overbought daily candle as your exit. So, RSI overbought can be an entry or an exit depending on your variables. Now you can start to see how difficult it is to find a trading strategy and how many options are possible. Keep that in mind as we cover the basic RSI trading ideas next.

By default the value for when RSI is considered overbought is above 70. Keep in mind that many traders opt to not use 70 as the level for overbought, so the ways you can craft your own strategy are truly endless. Below are a variety of ways you can use an overbought value in your trading strategy to get you started.

Trading every time RSI is overbought can be a good way of:

Dollar cost averaging into a long term position
Taking short term trades
Used as a signal that you should do lots of trading on lower time frames

Below is an example of RSI being overbought for 3 candles. As an example short term trade strategy, if you opened a short at the close of each candle and closed it the next day you would return -1.2% on day 1, 0.57% on day 2, and 2.62% on day 3 for a total return of 2%.

Trading whenever RSI enters overbought can be strategized as a way to join in the buying frenzy right when it reaches an area of contention. Everyone starts to wonder why it’s overbought, if they should buy now because they have FOMO(fear of missing out), or if this is the time to sell. If you were only taking a position when RSI enters overbought it would be at $246.43 on the chart below.

Trading an RSI reversal is when the previous RSI is overbought and higher than the current RSI. This might be a great strategy to use if you want to avoid entering a short too early in the buying frenzy of an overbought market. The example below shows when you would take a position if you were waiting for the reversal, $248.01. If you took a short here because you think price is cooling off and returning to a fair market value and then exited 5 candles later you would have a return of 4.92%.

By default the value for when RSI is considered oversold is below 30. Each way that overbought can be used, oversold can be used.

As we learned in RSI 101, a bullish RSI divergence occurs when price makes a new lower low, but RSI doesn’t. The challenges with this type of trade is that it’s tough to code and left up to visual interpretation. When you do identify a lower low that creates a bullish divergence you can decide to buy immediately. However, remember the challenges. If you’re not sure it might be worth waiting for confirmation that it is a bullish divergence. Confirmation could be to wait for:

1 more candle
RSI to move up
Price to close above the previous low

In the below image I mark the different action locations, with a yellow circle, of a bullish divergence.

Your trading options for a bearish divergence is just like a bullish divergence except for the psychological affect on traders of price moving higher instead of lower.

At the start of this post I discussed how trading is a sport and the activity before a breakout really exemplifies that idea. Before a breakout, buyers and sellers are battling for control or waiting on the sidelines for something new to happen. The win of control or new activity is the breakout. When that happens, volatility usually occurs as either the losing side gives up or puts more effort in because the stakes have changed. It’s no longer the same market it was yesterday. This creates lots of new buying opportunities. When there is a breakout it means that buyers have won. So, we can join the buyers or pay close attention for the next move.

Here is an example of a battle that occurred before a breakout and how buyers jumped in and sellers gave up. We can see the battle taking place by looking at RSI. The green lines contain the battlefield. The white circles on RSI show where the high and low of the battlefield were established and then how RSI moved towards but did not break the bounds multiple times until it broke out as shown by the yellow circle. Price then aggressively moved up as the market volatility picked up.

A breakdown is the opposite of a breakout, so imagine that sellers won the battle. How can we take advantage of that knowledge. How does the recent price activity compare to that information. If price activity has already broken down, maybe it is too late to enter a short position.

Another layer to your trading strategy is the addition of other indicators. They can act as additional confirmation or provide you a new set of information about volume or the trend to inform your opinion. Here are some examples:

If RSI oversold is when selling should be exhausted and buyers should start buying soon then how can we get confirmation that the buying has returned? How about we use MACD to see if we can find instances of when it is bullish and RSI is still oversold. Below is an example of what that looks like on a chart. The red circled areas show where RSI first entered oversold. The MACD on the bottom is showing that it is bearish as indicated by the white line being above the purple line. The yellow circles also show RSI being oversold, but this time MACD is bullish. We can see that by avoiding the earlier RSI oversold candles and waiting for MACD to give us bullish confirmation we get a much better entry.

When you are exploring the Candleverse and find a good trade, you can look for ways to confirm that trade or find a better entry/exit by looking up or down to different timeframes.

When RSI is overbought it means that a reversal in price is close to happening, but it also means there are lots of buyers and by taking a look at different timeframes maybe we can take advantage of that. Let’s say that RSI on the daily is overbought. Fantastic, lots of buyers. Below is the chart from above where we entered RSI overbought at $100. Let’s use that as our signal to look at the 4 hour and try and join the buying frenzy.

Below is the 4 hour chart where I’ve placed the moment that the daily closed as overbought. We can see that the 4 hour also says overbought, so let’s join the ride. Since we need to be careful that the buyers might be ready to leave, we want to exit quickly, so let’s exit when the 4 hour leaves overbought as indicated by the candle that closes at $101.1. The trade return would be 1.1%!

As you can see there are a variety of ways that traders use RSI in their trading strategies. Using the Candleverse, you can explore these different ideas and backtest their performance in seconds. To give you introduction into how, we’ve done studies on some commonly used idea variations to see if they are profitable. The ideas and links to their accompanying studies are:

For entering long trades:

Bullish divergence - If price makes a new lower low, but RSI doesn’t.

RSI oversold - Anytime RSI is below 30.

RSI enters oversold - If RSI moves from above 30 to below 30.

RSI oversold reversal - If previous RSI was oversold and lower than its previous value and RSI moved higher.

RSI leaves oversold - If RSI moves from below 30 to above 30.

RSI enters overbought - If RSI moves from below 70 to above 70.

For entering short trades:

Bearish divergence - If price makes a new higher high, but RSI doesn’t.

RSI overbought - Anytime RSI is above 70. FALSE (case study link)

RSI enters overbought - If RSI moves from below 70 to above 70.

RSI overbought reversal - If previous RSI was overbought and higher than its previous value and RSI moved lower.

RSI leaves overbought - If RSI moves from above 70 to below 70.

RSI enters oversold - If RSI moves from above 30 to below 30.