Relative Strength Index
One major challenge for both long and short term gold traders is methodology. What tools and techniques can you use to make your gold-trading strategy more successful?
One gold-trading technique is watching the so-called “relative strength index,” RSI for short. The RSI is a technical indicator that gold traders can use to compare gold’s recent gains to gold’s recent losses, thereby determining if gold is overbought or oversold.
Gold traders calculate gold RSI using the following formula:
100 – 100 / 1 + RS (the average of x days’ up closes / average of x days’ down closes)
The result of this gold-trading formula will range from 0 to 100. Typically, gold traders consider gold overbought or overvalued when its RSI approaches the 70 level; they thus consider it a good candidate for a sale. In contrast, most gold traders consider gold oversold or undervalued when its RSI approaches 30 level; they thus consider it a good candidate for a purchase.
RSI is also very useful in showing gold traders divergence with price.
Before explaining why, let’s make sure you understand divergence,
which occurs when the price of gold and the price of a related asset
(such as an index, or an indicator such as RSI) move in opposite directions.
To gold traders, divergence can be either a positive or a negative: When
the price of gold reaches a new low, but the indicator starts to rise, positive
divergence occurs; when the price of gold reaches a new high, but the
indicator starts to fall, negative divergence occurs. In gold trading,
divergence simply reveals major shifts in the direction of gold prices.
As an example of how gold RSI chart can be used with divergence, when the
price of gold reaches a new low, but RSI starts to rise, gold traders can
see that buying power is building and a rally often follows.
So, if you are interested in trading gold, consider learning more about and using RSI. Keep in mind, though, that many gold traders refrain from acting on RSI figures until they have confirmed the data using another technique, the moving average crossover. We will talk about the moving average crossover in more detail in another article.