Hello and welcome to CantosCharts Masterclass. I'm Sandy Jadeja, Chief Market Strategist for CMS FX. We're going to continue looking at technical indicators, and as always, everything we teach you here is simply for education and information purposes only.

So today, we'll move on and take a look at something called the Relative Strength Index. The Relative Strength Index is actually quite a popular indicator and is rapidly becoming useful for day traders now. So I'll go into some ideas as to how you can use this particular indicator.

So what exactly is the RSI, which is sometimes referred to as short. Well, first of all, the RSI is a momentum oscillator. In other words, it's going to be useful for identifying peaks and troughs in markets that are trading sideways. I'm going to come back to that point in just a second. It indicates strength or weakness over a period of time, and the settings can vary for different timeframes. And as I said previously, that this does not pick tops and bottoms. None of the oscillators picks tops or bottoms. But they can do for a short period of times once markets are moving sideways.

Now, if we take a look at this particular chart over here, the RSI is at the bottom of the chart, and it's basically a measure of the momentum of price movement. So in other words, look at the strength of the current movement in the market over a given period of time.

We can look for extreme readings and we can also observe divergence within the indicator and the price itself.

Now, if we take a look at the index itself, the RSI, the first thing we notice is this red line. And that is actually the indicator itself. Secondly, we notice that there are two blue lines - one on the top side and one on the bottom side. When the RSI indicator reaches towards the top side, it can be considered that the markets may be overbought or too expensive. On the other hand, if the indicator has reached towards the lower side, it can be considered as the markets being oversold or cheap.

So we'll take a look at how to use this analogy in the financial markets. So let's take a look over here at the FTSE 100 weekly charts. See that the markets made a nice bull trend and then a decline, and then recently we've actually been heading toward the upside. So the indicator itself, what has this provided us? What sort of information has this given us?

Well, just towards the left-hand side over here, we can see that the indicator was reaching extreme levels towards the upside. This red arrow indicates that the market had actually topped out and then started to decline. However, notice that there's a divergence. The price actually continued higher, but the indicator continued to go sideways and slightly lower. There is clearly a relationship between these two, but they're not in tandem. They're going into opposite directions.

So I've always said that price is the key indicator. So if price is moving up, and the indicator is moving sideways or lower, that's telling us that we should actually be paying more attention to price itself rather than the indicator.

Now let's take a look over here towards the right-hand side. We can see a second case of divergence. The indicator came right down into the extreme area, where the market was considered as being oversold. The blue arrow indicates that we should actually start seeing a move towards the upside. And we did, short-term.

However, the market then continued to decline towards the downside, but the indicator on the other hand started to move towards the upside. So again, there's a clear divergence here. So how would we trade this? Essentially, I'd be looking at price, and I'd be looking for breakouts above recent highs to tell me that this market is indeed looking stronger or looking towards higher prices.

The indicator itself would have given us an early warning signal to say actually the market's heading lower, but the indicator itself is strengthening. So use them conjunctively to say I'm looking for break on higher prices supported by the indicator, rather than trying to say that this indicator has reached the oversold area, the market has to go up. The market doesn't have to go up at all.

In this example here, we're now looking at a daily chart and this is gold. So let's take a look at this region over here. The indicator itself headed higher. It was reaching the extreme overbought area and of course, gold reached a high of $1229 in December 2009, and then the indicator headed below the overbought zone and of course, the market started to trade sideways to lower. Okay?

Now, notice, however, that the blue line is only showing on the upside and not on the downside. That is suggesting that the price of gold is actually quite strong. We haven't seen this indicator head toward the oversold area at all. So it appears to me that currently the price of gold is still looking strong, even though the market has been trading sideways. I would be looking for breaks above the recent highs for a continuation towards the upside.

In this example here, we have the FTSE 100 weekly chart again. What I'm trying to highlight over here is notice that the indicator has lower highs and lower lows. And what I've done is to draw a trend line literally above the highs, and once I see a breakout above the trend line on the indicator, then I'd be looking for the market to head higher.

So right at this point here where we see the blue arrow, we can see that the trend line has been broken and the market indeed actually went higher. So that's a very good way of trading with trend lines on indicators.

So, trading with the RSI. In terms of settings, for shorter-term traders, for day traders, you can use the settings of 5 or 8. Going into intermediate-term areas, we could be looking at 14 and 20. Now the 30-70 is just not the perfect setting, but it's an ideal setting for where you may be looking for overbought or oversold zones. There are times, of course, you could look at 20 and 80, which was traditionally used back in the 1980s. But I think at the moment, the 30s and 70s and working quite well.

Obviously keep an eye on divergences with price, and try to use multiple timeframes as we've discussed in previous lessons.

As I said previously, this is not for picking tops and bottoms. This is simply for alerting you when prices could possibly be at extreme levels. The RSI indicator is useful for identifying the extreme levels, but can fail in very strongly trending markets. And the divergences or the breaks of trend lines provide alternative ways or alternative signals on using this type of methodology.

In the next lesson we'll take a look at more ideas on trading with the RSI. In the meantime, have a great trading week. This is Sandy Jadeja with CantosCharts Masterclass.