RSI Breakout Strategy - Advanced Forex Strategies

RSI Breakout Strategy

RSI Breakout Strategy

The Relative Strength Index or RSI for short is a versatile indicator that is often used in conjunction with a trend following strategy. The RSI oscillator developed by Welles Wilder is used in a variety of ways, starting from spotting divergences to trading breakouts. The RSI breakout strategy is one of the most popular ways the RSI is used to trade price congestion or consolidation. This article explains how a trader can make use of the RSI as way to spot breakouts when prices enter a range.

We make use of the RSI oscillator with the default settings of 14, applied to close. Traders can also experiment with other RSI settings including a 7 or 21 period as well. However, traders should note that the smaller the RSI setting is, the more sensitive it is to price and the longer the time frame is, the less sensitive it is. We therefore make use of the 14 period RSI as we find it to be more balanced. For the time frame, the breakout strategy can be applied to any timeframe. However, the time frame should be of importance. For example, breakouts from a 15 minute chart usually yields 20 – 50 pips on average before prices start to pullback, while on a daily chart; we can expect to see 50 – 100 pips on average depending on how strong the breakout is.

Once the RSI is applied to the chart and the time frame of your choice, the first step is to look for price consolidations. While this is subjective a simple rule of thumb is to bear in mind that the more number of prices bars that are trading in a range, the stronger the breakout is likely to be.

Trades are entered based on an RSI breakout off the 70 or 30 levels to go long or short respectively

RSI Breakout Strategy – Long set up

The first chart below illustrates an RSI breakout strategy long set up.

RSI Breakout – Long set up

In the above chart, we can see prices ranging sideways, marked by the region denoted by ‘Price Consolidation’ we mark the high and low of this consolidation range and wait for RSI to break above the 70 level. An important fact to bear in mind is to wait for at least one or two candles before entering a position, to avoid being caught in a bear trap.

After prices broke out of the range and the RSI confirmed by moving and staying above the 70 level, we take a long position on the candle’s close with stops at the low of the signal candle. For exiting the trade, we simply exit when the RSI dips back to 70. The above long set up illustrates a quick RSI breakout set up which yield some decent profits in a short span of time.

RSI Breakout – Short set up

In the next chart, besides illustrating a short set up, we also show how the RSI breakout strategy can help traders to minimize their losses.

RSI Breakout – Short set up

Firstly, in the above chart, after the price consolidation was identified, we got a long signal marked by the up arrow. Prices briefly traded higher before the RSI signaled to close the trade. Despite a small stop loss, the above signal to exit resulted in a near breakeven exit from the long trade. Staying with the chart, prices then entered back into the range and then broke out to the downside, which was signaled by the RSI to go short. We enter the market short with a relatively tight stop and exit when the RSI attempted to rise back above the 20 level. The above short set up yielded a relatively large profit in comparison to the risk and the previous losing trade.

RSI Breakout Strategy – Simple, efficient

The RSI breakout strategy as illustrated in the above charts proves to be a relatively robust trading strategy that can be applied to different time frames and markets. The strategy is self sufficient in that, it signals traders when to exit and enter the markets and offers a tight stop loss while leaving the profits open as illustrated in the short set up. With due practice, the RSI breakout strategy can be a great way to scalp the markets.

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