The RSI 70/30 rule is a widely recognized principle in forex trading, guiding traders in identifying potential entry and exit points based on market conditions. 

While some traders rely on it as a key component of their strategy, others caution against using it in isolation. But what makes this rule so significant?

Market fluctuations often create uncertainty, leading traders to make decisions that result in losses. Identifying the right moments to buy or sell is crucial to long-term success. 

The RSI 70/30 rule provides a structured approach to assessing whether an asset is overbought or oversold, helping traders refine their strategies and improve their decision-making process.

This article will explain the RSI 70/30 rule in depth, its mechanics, applications, and potential limitations.  

By the end, you will gain a clear understanding of how to incorporate this indicator into your trading strategy effectively.

Let’s begin.

What is RSI?

The Relative Strength Index (RSI) is a momentum indicator used in technical analysis to measure the speed and change of price movements. 

It ranges from 0 to 100 and helps traders determine whether an asset is overbought (potentially due for a price drop) or oversold (potentially due for a price increase).

Now, let’s expand on the 70/30 rule in detail.

What is the RSI 70/30 Rule

The RSI (Relative Strength Index) 70/30 rule is a popular trading strategy used by forex traders to determine when to buy or sell a currency pair. 

The RSI is a momentum indicator that measures how strong or weak a currency is based on recent price movements.

When the RSI goes above 70, the currency is overbought (it has increased too much in price, and traders expect it to drop soon).

When the RSI falls below 30, the currency is oversold (it has dropped too much in price, and traders expect it to rise soon).

Traders use this rule to avoid buying a currency at an overbought level (when it’s too high) and to avoid selling it at an oversold level (when it’s too low).

RSI Above 70

When the RSI crosses above 70, it suggests that an asset might be overbought or overvalued, meaning the price has been increasing too quickly. 

This often happens when there is strong buying pressure, and traders rush to buy the asset.

When an asset is overbought, it means buyers have been aggressively pushing the price up.

Prices don’t go up forever, eventually, traders take profits, and the price can reverse or correct itself.

The RSI above 70 does not guarantee an immediate drop, but it signals that the asset may be overextended.

How Traders Use It

• If a trader sees RSI above 70, they might avoid buying at that moment because the price could be too high.
• Some traders sell their holdings when the RSI crosses above 70, locking in profits before a potential reversal.
• Aggressive traders might even start betting against the asset (short selling), expecting the price to drop soon.
• Smart traders combine RSI with other indicators (like candlestick patterns or moving averages) before making a move.

Let’s take, for instance, a stock called XYZ Corp has been rising for weeks. Its RSI hits 78. A trader sees this and decides to sell their shares, anticipating that the stock is overbought. 

Soon after, the stock price drops by 10% as profit-taking begins.

RSI Below 30

When the RSI falls below 30, it suggests that an asset might be oversold or undervalued, meaning the price has dropped too much, too quickly. 

This typically happens when there is strong selling pressure.

When an asset is oversold, it means there has been excessive selling.

Prices don’t keep falling forever, eventually, traders see a bargain and start buying, leading to a price rebound.

The RSI below 30 does not always mean an immediate price increase, but it signals that the asset could be due for a bounce.

How Traders Use It

• Some traders see an RSI below 30 as a sign to buy because the asset is considered “cheap.”
• Traders wait for confirmation, like a reversal candlestick pattern, before entering a trade.
• If a trader owns the asset, they might not sell it in panic, knowing it is oversold and could recover soon.

For example,

A cryptocurrency called CryptoCoin crashes, and its RSI drops to 25. Some smart traders see this as an opportunity to buy, believing it is oversold. 

A few days later, the price bounced back up by 15%, rewarding those who bought at the low.

How the RSI 70/30 Rule Works

Let’s say, you are buying and selling shoes.

If a certain shoe brand suddenly becomes popular, the price rises because everyone wants to buy it. But after a while, the price becomes too high, and fewer people want to buy it. 

This is similar to an overbought market (RSI above 70).

On the other hand, if a shoe brand is not selling well, its price drops. At some point, the price becomes so low that many people rush to buy it. 

This is similar to an oversold market (RSI below 30).

Forex traders use the RSI indicator to check if a currency is overbought or oversold before making a trade.

Example of Using the RSI 70/30 Rule in Forex

Let’s say you are trading the EUR/USD currency pair. You check the RSI and see it is at 75. This means the currency pair is overbought, and there is a high chance the price will drop soon. Instead of buying, you wait for the price to fall.

Later, the RSI falls to 25, meaning the pair is oversold. This suggests the price is too low and might rise soon. So, you decide to buy.

This strategy helps you avoid buying at high prices and selling at low prices, which is a mistake many traders make.

Limitations of the RSI 70/30 Rule

The RSI 70/30 rule is useful, but it is not perfect. Below is why:

1. False Signals

RSI can stay above 70 or below 30 for a long time in strong trends.

Just because RSI is above 70 doesn’t mean the price will drop immediately.

2. Best Used with Other Indicators

Many traders use RSI with moving averages, trendlines, or volume indicators to confirm signals.

Example: If RSI is below 30, but the overall trend is downward, the price might continue falling.

Overbought Doesn’t Mean “Sell Everything”:

If an asset is in a strong uptrend, it can stay above 70 for weeks before reversing.

Instead of selling immediately, traders often wait for a clear bearish signal.

Oversold Doesn’t Mean “Buy Immediately”:

In a market crash, assets can stay below 30 for a long time.

Example: A stock in a severe downtrend can remain oversold for months before recovering.

How to Use the RSI 70/30 Rule Effectively

Follow these steps:

1. Combine with Other Indicators

Use RSI with moving averages, MACD, or support/resistance levels.

2. Check Higher Timeframes

Look at daily and weekly RSI levels to confirm signals.

3. Avoid Trading Against Strong Trends

If a currency is in a strong uptrend, an RSI above 70 may not mean it will drop immediately.

4. Use Stop-Loss Orders

Always set a stop-loss to protect yourself from unexpected price movements.

How is RSI Calculated?

The Relative Strength Index (RSI) is calculated using a formula that measures the average gains and losses over a specific period (usually 14 periods).

RSI Formula

RSI = 100 – (100) / 1 + RS

Where

• RS (Relative Strength) = Average Gain / Average Loss
• Average Gain = (Sum of gains over 14 periods) / 14
• Average Loss = (Sum of losses over 14 periods) / 14

Steps to Calculate RSI

Choose a period (typically 14 days).

Calculate the average gain and average loss over those 14 days.

Compute the Relative Strength (RS) by dividing the average gain by the average loss.

Plug RS into the RSI formula.

For example

Let’s say we track a stock’s closing prices over 14 days.

If the average price gain is 2% and the average price loss is 1%, then:

• RS = 2% / 1% = 2

• RSI = 100 – (100 / (1 + 2))

• RSI = 100 – (100 / 3) = 66.67

This means the stock is close to the overbought level.

What is a Good RSI Number to Buy?

A good RSI number to buy depends on your trading strategy, but generally:

RSI Below 30 (Oversold) Buy Signal

If the RSI is below 30, it suggests the asset is oversold and could be a good buying opportunity.

However, traders often wait for confirmation (e.g., RSI rising above 30 or a bullish candlestick pattern).

RSI Between 30 – 40 – Early Buying Opportunity

If RSI is between 30 and 40, some traders start accumulating the asset, expecting an upward reversal.

RSI Below 20 – Extremely Oversold

If the RSI is below 20, the asset is deeply oversold, but caution is needed because it could keep falling in a bear market.

What Number is RSI Buy?

The most common RSI buy levels are:

• Below 30 – Classic buy signal.
• Between 30 and 40 – Potential early entry.
• Crossing above 30 – Confirmation of an uptrend.

Frequently Asked Questions

What happens if RSI stays above 70 for a long time?

• If the RSI remains above 70, it means the currency is strongly trending upwards. However, it does not mean the price will drop immediately. Always wait for confirmation before selling.

Can I use the RSI 70/30 rule alone?

• It is not advisable to rely only on the RSI 70/30 rule. It works better when combined with other technical indicators.

What is the best RSI setting for forex trading?

• The default RSI setting is 14 periods, but some traders adjust it to 7 or 9 periods for short-term trading.

Is RSI good for beginners?

• Yes! RSI is one of the easiest technical indicators to use, making it great for beginners in forex trading.

Conclusion

The RSI 70/30 rule is a tool for forex traders, helping them make better decisions by identifying overbought and oversold conditions. 

By following this rule, traders can avoid buying when prices are too high, reducing the risk of entering at the peak, and prevent selling when prices are too low, maximizing profit potential.

However, while the RSI 70/30 rule is highly effective, it is not foolproof. Market trends, news events, and other factors can influence price movements beyond what RSI alone can predict.

To improve accuracy and make better trading decisions, it is essential to combine RSI with other indicators like moving averages, support and resistance levels, and volume analysis.

If you want to succeed in forex trading, start applying the RSI 70/30 rule today. Keep practicing, analyze past trades, and learn from both successes and mistakes. 

Always trade smart, manage your risks wisely, and stay informed.