Technical analysis of FOREX by RSI Indicator

SEYED HADI MIR YAZDI ZIBA HABIBI LASHKARY

Faculty of Business and Accountancy (FBA), International Business School (IBS), University
University of Malaya (UM) Technology Malaysia (UTM)
Kuala Lumpur, Malaysia Kuala Lumpur, Malaysia
[email protected] [email protected]

IZLIN BINTI ISMAIL

Faculty of Business and Accountancy (FBA),
University of Malaya (UM)
Kuala Lumpur, Malaysia
[email protected]

Abstract: In these days, trading automation is one of the major value of currency between that country and other countries is put on
topics in the field of financial research. Buy and sell are the key rule interest rate differentials, the agent who trade by using fundamental
to an automated trading system which is possible to generate by analysis is fundamentalist[4].
various technical indicators in Forex. Benefits and disadvantages of
each indicators, has its own. The evaluation is based on application
of the RSI indicator for four currencies namely EURUSD, GBPUSD,
USDCHF and USDJPY individually to identify effectiveness of the 1.2. Technical Analysis in Forex
indicator regarding to the amount of profit generated, using hourly Technical analysis (TA) or charting that usually include price and
data of market stretch from January 2001 to December 2010. Virtual volumes by utilizing historical data created by market reaches at
Historical Trading Software (VHTS) is developed for the purpose of future currency price movements[5]. Although TA in general has
computing the indicator based on its original formulas and been used for more than hundred years, the field had received scant
interpretations; for applying the assumptions; for trading based on attention until recently by academicians who had been more focused
buy and sell signals generated by the RSI indicator.
on fundamental approaches [6-8].Quantitative and qualitative are
Keywords: Forex, RSI, Technical analysis, Fundamental Analysis, two main analytical concepts for TA. The quantitative- based
Indicator analysis tries to make indicators such as MACD and P-SAR while
the qualitative-based analysis depends on clarification of the shape of
geometric patterns like levels of support and resistance and double
1. Introduction bottoms[7]. Successful TA is constructed on three basic principles
Trading in foreign currencies began in 1973 following the collapse of [1]:
the Bretton Woods agreement under which gold held by central
banks underpinned currency values. Forex is a free market in which
currency prices are based on supply of and demand for a particular
currency [1]. 1.3. Profitability
The Forex market has several distinct advantages over other financial Many studies show that TA provides valuable financial signals [8]
markets, such as: operation on a 24-hour basis 5 days a week, no and recent empirical studies also provide increasing support for TA.
fixed location, and an over-the-counter market. Besides, Forex In addition, the subsequent researchers concur with this actuality;
market currently generates a daily volume of over USD 3.2 trillion Sweeney (1986, 1988); Brock, Lakonishok, and LeBaron (1992);
thereby making it the largest financial market [2]. Any currency can Blume, Easley, and O’Hara (1994) ; Neely, Weller, and Dittmar
be traded as long as there is no restriction by central banks issuing (1997); Chan, Jegadeesh, and Lakonishok (1996, 1999); Gencay
the currencies [3]. Ding et al. (2010) added that rapid technological (1996, 1998, 1999); Brown, Goetzmann, and Kumar (1998);
changes to increase efficiency in Forex transactions have enabled the Rouwenhorst (1998); Neely and Weller (1999); Chang and Osler
market to grow at a tremendous pace by reducing entry and (1999); Lo, Mamaysky, and Wang (2000); Chan, Hameed, and Tong
transaction costs as well as overcoming geographical limitations. (2000); and Hsu and Kuan (2004) [9-18]. Their findings imply the
popularity of TA over FA is due to the fact that the former can “beat
the market”.
Moreover, (Papadamou and Tsopoglou, 2001) indicated that TA
1.1. Fundamental Analysis in Forex Trading
approach can generate higher profit against a simple “buy and hold”
The best way for determining asset valuation based on key
strategy which is a fundamental analysis [19]. In during on 8 years
underlying factors is fundamental analysis (FA). Significant factors
from 1989 until 1996 for finding out whether TA is profitable, they
in forex transactions which would provide a basis to determine that
tried to evaluate USDDEM and USDGBP in their study. Also,
country’s currency’s value are economic indicators of a country and
according to Lui (1998), more than 85% of Forex traders in Hong
predictions of future economic performance. Accent to arrive at a fair
Kong using both fundamental and technical analysis together to
forecast future price movements but they believe TA is more useful 3. RSI
in predicting trends than FA [20]. Easy interpretation makes Relative Strength Index (RSI) helps
traders determine the power of all downward movement in
opposition to the power of all upward movement in a specific
2. Indicators period. The formula for calculating RSI is given in Equation 3.1 [21].
The mathematical calculations based on currencies information such
RSI = 100 – [100/ (1+RS)] Equation 3.1
as volume and prices (opening, low, high and closing) with a specific
Where; RS (Relative Strength) = Average Gain / Average Loss
formula called indicators. TO forecasting future price changes can
use from the value of result. They are used to provide clearer and If the difference between each closing price with its previous
extra information about market to be used by investors to make better closing price is a negative value it is called loss and if it is
decisions. Indicators based on their functions are sorted to four positive it is called gain. In other word, RS is calculated in two
groups; trend indicators, volume (strength) indicators, volatility steps; for first value of RS which is at the beginning point of
indicators and momentum indicators as follow [5]. calculating RSI; and the second and subsequent value of RS to
continue computation of RSI. Generally, it is calculated with a
14-day simple moving average and the formulas are given in
Equations 3.2 and 3.3 [22].
2.1. Trend Indicators Equation 3.2
Explain continue to move in one direction in the exchange rate over
time, called a trend. Trends have three directions; sideways, down First Average Gain (Loss) = Sum of Gains (Losses) over the
and up. Trend indicators level variable rate data to produce a mix of past 14 periods / 14
market direction. There are some Trend Indicators for example
Moving Averages (MA), MACD, P-SAR and Trend lines. The second, and subsequent, computations are based on the
previous averages and the present gain and loss as it is clear
from the Equation 3.3.
Equation 3.3
2.2. Volume (Strength) Indicators
Market strength illustrates the market attitude intensity with Average Gain (Loss) = [(previous Average Gain (Loss)) * 13
reference to a rate by inspecting the market positions in use by a + current Gain (Loss)] / 14
variety of buyers and sellers. Volume is the basic data to compute
these indicators. Their hints for buyers and sellers are coincident or There are three points of values which play a critical role in
leading the market. There are some Volume Indicators for example: finding the signals as shown in Figure 3.5 and those values are
Volume, Money Flow Index (MFI), On-balance volume (OBV) and 30, 50 and 70. Whenever the RSI crosses 30 or 50 upward, it is
Force Index (FI). considered a buy signal and whenever RSI passes 50 and 70
downward, it is considered a sell signal. In this study, whenever
the value of RSI in the first period is less than 30 or 50 and it is
2.3. Volatility Indicators more than 30 or 50 in the second period, there is a buy signal in
There is a common term for explaining the size or magnitude of tick- the third period. For sell signal, whenever the value of RSI in
to-tick price oscillation independent of their trend direction called the first hour is more than 50 or 70 and is less than 50 or 70 in
Volatility. By and large, variations in volatility tend to direct the second period, there is a sell signal in the third hour.
variations in prices. Average True Range (ATR), Bollinger
Bands (BB) and Standard deviation (σ) are some example of
Volatility Indicators.

2.4. Momentum Indicators

Momentum is a general term used to illustrate the rapidity at which
rates move over a particular time period. Momentum indicators
specify the weakness or strength of a trend as it grows over time.
Momentum indicators provide clear signals for market participants.
Relative Strength Index (RSI), Stochastic Oscillator (STOCH)
and Williams’ %R are some example of Momentum Indicators.

Figure 3.4 Buy and sell signal from RSI indicator

2.5. Function of Indicators
Thus, there are many indicators in market with different formula and
usage. The main function of them is giving signal to enter; open the
buy or sell orders, and exit; close the opened orders from market.
Since, finding the optimum point of price to buy or sell is the main
concern of traders, indicators are trying to solve this problem and
they are used to find the best point of price for buying or selling.
There are several indicators which are more popular among traders
such as Moving Averages; Bollinger Bands; Relative Strength Index
(RSI); P-SAR (Stop And Reverse); Moving Average
Convergence/Divergence (MACD); and Stochastic Oscillator.
 3.1. RSI advantages and Properties
The data from this online data base are exported into the spreadsheets
including over 60,000 rows for each currency; frequency is hourly
RSI is a very good indicator to refer for confirmation for any entry in (period 2001-2010). An example of the data on MetaTrader software
any simple or complex trading system. For current trading method it is shown in Figure 3. After compiling the data, they are analyzed and
advices well on entries, but opportunities occur not that often. The processed. It covers the first research question: what are the volume
RSI has the advantage of being a very elegant indicator, in that it's and open, high, low and close prices for each currency in hourly
movements are smooth, and it can fit into a neat package between 0 basis for the years 2001 -2010.
and 100. It has the added advantage of being used by many traders
out there, which is not only a testament to its abilities, but it also
makes its signals self-fulfilling at times. When used to indicate
divergences, it can be quite powerful.

4. Scope of the Study

The data used in this study are real and worldwide some which are
selected within the scope of this study; trading on hourly basis and
for 10 years starting from January 2001 until December 2010. The
hourly data for ten years makes it huge with more transaction to have
reliable results. This study is conducted to evaluate the one main
indicator for predicting the market in order to buy or sell on the right
time to gain profit and avoid lose.
Four currencies; EURUSD, GBPUSD, USDJPY, USDCHF are Figure 3: An example of the data on MetaTrader software
evaluated with the employment of P-SAR at which buy and sell
signals are identified. Period of the study is ten years starting from MetaTrader is one of the key tools for this study. It is Forex trading
January 2001. online software which widely used by foreign exchange traders. The
To avoid the effects of one indicator on the other’s result, the traders can sell or buy via this online software. To provide facility for
currencies evaluated separately. It means for each currency, indicator traders, MetaTrader generates the graphs and charts of the indicator
applied and evaluated separately; so there are one indicator and four based on live and historical data.
currencies and combination of them are four cases which are called The other tool is used for analysis and processing the data, is
traders. Thus, there are four virtual traders that each one working just Microsoft Excel software. Since the data are wide and calculations
with the indicator and currency. are based on each item, Virtual Historical Trader Software (VHTS) is
developed based on Microsoft Excel to apply assumptions and trade
based on them on historical data. Moreover, to cover the lack of
Microsoft Excel formulas and to increase accuracy of calculations,
5. Methodology, Data Acquisition and Assumptions
TA-Lib program is added to Excel. It is a program which adds
The research areas on this project are based on the preface and
indicator’s formulas to Microsoft Excel function list.
literature review prior this chapter. This chapter will outline the
VHTS is developed for application of assumptions in order to create
research design for this project and the way in which the research
a virtual circumstance for investors to trade like real trading on
was accomplished. The methodology as presented in Figure 2 has
historical data considering the assumptions. VHTS has ability to
been adopted in order to meet the objectives of this study.
calculate indicator for each row or period of spreadsheet based on
Data types required for the current study are hourly opening, high,
given data. Besides, it can open and close sell and buy orders based
low, closing prices and trade volume for four currencies within 24
on assumptions and signals created by indicator. Finally, it can
hours a day of weekdays from January 2001 to December 2010. calculate profit/loss for all and each order.
The data are obtained from online data base of Foreign Empirical method has been applied for evaluating the profitability of
Exchange Market on MetaTrader software. using SAR indicator applied on four currencies. After collecting
historical data from Meta Trader software the data are assessed to
make sure they are the required data. The assessed data are used to
calculate indicator. This indicator is calculated in VHTS with its
unique formula which is explained and default assumptions
suggested by its inventor. To prevent any error and mistake in VHTS,
all formulas and assumptions have been rechecked and the software
has been run several times to make sure that the results are correct
and reliable. It covers the second research question: what are the
hourly values of the selected indicators for each currency.

6. Data Collection and Assumptions

After obtaining and interpretation of RSI indicator, VHTS provided
the results as demonstrated in Table 4.11. Although the results are
different for each currency, it should be considered that the
conditions of all currencies for using RSI are the same; trading with
the same assumptions and interpretations. Moreover, the results
indicate RSI is not a profitable indicator for these currencies with
applying its interpretations considering this study’s assumptions.
Figure 2: The research process flow diagram However, application of RSI for USDJPY is more effective
compared to other currencies since its attributed loss is lower than
them.

Table 1 demonstrates results of implementing RSI for four different

pair-currencies which are shown in four separate columns. First three
rows are showing produced profit that is split to two parts, sell and
buy profit. The same thing is displayed for loss in second three rows.
The third three rows are demonstrating total profit/loss and its sell
and buy division. Fourth three rows are showing the number of sell
and buy transactions and total number of transactions for each pair-
currency. Finally, the last three rows are displaying ending balance,
last trading date and paid commission to broker.

The following assumptions are considered in this study in order to

unification the twenty traders’ condition. With the employment of
these assumptions, each trader will be isolated from everything that
can deflect the results. These assumptions have been chosen based on
researcher’ experiences in Forex market and studying Forex market, 7. Process
capital management and risk management to make the result Results and discussion is presented according to the research
comparable and unified. methodology format: data collection and assessing; data processing;
calculating the RSI with the aid of Virtual Historical Trading
 Trading period is ten years starting from 1st January of 2001. It is Software (VHTS). Then buy and sell signals from interpretations of
because for less than ten years period the results are not reliable the indicator for the four currencies EURUSD, GBPUSD, USDCHF
and useful. In addition, more than that the data become huge and and USDJPY have been determined. After that, the trading software
difficult to process them and out of scope of this study. based on the assumptions has been run to obtain profit/loss of each
 Traders can only trade one of the four pair currencies which are currency regarded to application of the indicator, so there are four
EUR/USD, GBP/USD, USD/JPY and USD/CHF. These currencies virtual traders.
are chosen because according to Oh (2007) European, North
American and Japan Forex market efficiency is higher than the
other foreign exchange market and it helps to eliminate effects of 7.1. EURUSD
other variables on results. With the employment of RSI for EURUSD in order to identifying the
 Traders cannot open more than one position at the same time and signals to enter and exit the market, 5887 orders include 2859 buy
upon a new order, the pervious order would be closed if still is orders and 3028 sell orders has been proceeded. Total numbers of
open. buy and sell of EURUSD with the employment of Relative Strength
 Take profit and stop loss for each order is 30 pips. It reduces the Index (RSI) indicator during ten years (2001-2010) is presented in
risk of losing big amount and of course makes the profits small Figure 4.
too.
 The volume of order cannot be more than 7% of the traders’
capital balance. This assumption is to reduce lack of capital risk
when the fluctuation and volatility are high.
 Initial capital for each trader is $10,000
 Trading time is 24 hours and 5 days a week and upon receive the
buy or sale signal from the indicators
 If a position do not reach to its level of take profit or stop loss and
there is no new order, the order will be closed automatically after
10 periods (hours) and profit/loss is calculated based on the last 10
hours.
 There is no limitation in amount of each order since it is 7% of the Figure 4: Final percentage of EURUSD buy and sell using RSI
capital balance. indicator for the years 2001 to 2010
 Minimum order is 0.01 of the lot
The ordering is stopped in October 2007 since the capital was not
Table 1: Summary of the final outcomes using RSI indicator and its enough to carry on the trading. It means trading with RSI results loss
related interpretations for the years 2001 to 2010 more than benefit and it caused reducing capital while the time is
passing. Moreover, the final loss generated by buy orders is 1266
pips which is resulted from 35615 pips profit and 36881 pips loss
while the final loss created by sell orders is 3355 pips which is
resulted from 36680 pips profit and 40035 pips loss. At the end of the
day, there are 4621 pips loss generated by sell and buy transactions
from 72295 pips profit and 76916 pips loss.

The more detail results of using this indicator for EURUSD is given
in Table 2 and as it is clear from the Table, 4621 pips loss created
within first seven years.

Table 2 Yearly outcome of EURUSD trading using RSI indicator

 7.3. USDCHF
There are 1605 transactions including 785 buy and 820 sell orders
which are generated by employment of RSI indicator for USDCHF.
Total numbers of buy and sell of USDCHF with the employment of
The relationship between profit/loss of buy and sell is the opposite. It Relative Strength Index (RSI) indicator during ten years (2001-2010)
means when buy orders resulted in less loss or even profit, the sell is presented in Figure 6.
orders generate higher loss and vice versa. Furthermore, it is clear
that the loss created by buy signals is less than sell signals’ loss due
to profitability of buy signals for 2004 to 2007.

7.2. GBPUSD
With the implement of RSI for GBPUSD in order to discovering the
signals to buy and sell the market, 1560 orders include 778 buy
orders and 782 sell orders has been proceeded. Total numbers of buy
and sell of GBPUSD with the employment of Relative Strength
Index (RSI) indicator during ten years (2001-2010) is presented in
Figure 5.

Figure 6: Final percentage of USDCHF buy and sell using MACD

indicator for the years 2001 to 2010

The last order has proceeded in October 17th 2002 regarding

finishing the capital. As a result of those transactions 4683 pips loss
has been made which included 21384 pips profit and 26067 pips loss.
In other word, 3355 pips loss of sell transactions and 1328 pips loss
of buy transactions created 4683 pips final loss within two years. The
3355 pips loss which created by sell transactions included 9940 pips
Figure 5: Final percentage of EURUSD buy and sell using RSI profit and 13295 pips loss. While, the 1328 pips loss generated by
indicator for the years 2001 to 2010 buy orders included 11444 pips profit and 12772 pips loss.
Yearly details of profit and loss using the foresaid indicator for
The ordering is stopped after two years in September 2009 since the USDCHF are presented in Table 4. The table shows the progress of
capital was not enough to continue the trading. It means trading with the 4683 pips loss created by sell and buy orders within two years.
RSI results loss more than benefit and it caused decreasing capital Besides that, it shows losses of sell transactions are more than losses
while the time is passing. Moreover, the final loss created by buy from buy transactions in all two years and overall.
orders is 2600 pips which is resulted from 8846 pips profit and 11446 Table 4: Yearly outcome of USDCHF trading using RSI indicator
pips loss while the final loss created by sell transactions is 3067 pips
which is resulted from 8671 pips profit and 11738 pips loss. Finally,
there are 5667 pips loss created by sell and buy orders from 17517
pips profit and 23184 pips loss.

Yearly details of profit and loss using the foresaid indicator for
GBPUSD are presented in Table 2. The table shows the progress of
the 5667 pips loss generation within two years with no profit
generated by buy and sell orders within that. Moreover, the
relationship between losses of buy and sell are the opposite since 7.4. USDJPY
when buy signals resulted in less loss the sell signals generate higher RSI signals for USDJPY work almost same as the other three
loss and vice versa. currencies since they also generated loss. Moreover, trading could
not be continued after October 2005 since the capital was not enough
for continuing the trade. RSI signals resulted 3778 pips loss which
Table 3: Yearly outcome of GBPUSD trading using RSI indicator included 42870 pips profit against 46648 pips loss. This 3778 pips
loss contained 2069 pips loss from sell transactions and 1709 pips
loss from buy transactions. There are 3384 transaction created by RSI
interpretations which include 1719 sell transactions and 1665 buy
transactions. Total numbers of buy and sell of USDJPY with the
employment of Relative Strength Index (RSI) indicator during ten
years (2001-2010) is presented in Figure 7.
 To unify the trading condition in order to make the results
comparable, a series of assumptions has been applied as follows:

 Trading period was ten years starting from 1st January of

2001.
 Traders can only trade one of the four pair currencies
which are EUR/USD, GBP/USD, USD/JPY and
USD/CHF.
 Traders cannot open more than one position at the same
time and upon a new order, the pervious order would be
closed if still is open.
Figure 7: Final percentage of USDJPY buy and sell using RSI  Take profit and stop loss for each order is 30 pips.
indicator for the years 2001 to 2010  The volume of order cannot be more than 7% of the
traders’ capital balance.
 Initial capital for each trader is $10,000
Table 5 which show the yearly details of buy and sell orders. It  Trading time is 24 hours and 5 days a week and upon
indicate that the relationship between losses of buy and sell are the receive the buy or sale signal from the indicators
opposite since when buy signals resulted in profit the sell signals  If a position do not reach to its level of take profit or stop
generate loss and vice versa. Moreover, in all five years trading loss and there is no new order, the order will be closed
period either buy transactions or sell orders generated profit but not automatically after 10 periods (hours) and profit/loss is
enough to cover the other side loss except in 2003. calculated based on the last 10 hours.
Table 5: Yearly outcome of USDJPY trading using RSI indicator  There is no limitation in amount of each order since it is
7% of the capital balance.
 Minimum order is 0.01 of the lot.

These assumptions have been chosen based on researchers’

experiences in Forex market and studying Forex market, capital
management and risk management to make the result comparable and
unify. The following findings have been obtained from the current
study:

 RSI had better results with trading with EURUSD.

8. Analysis  However, all four traders could not reach to the end of ten
Final profit/loss of all four currencies trading with the employment of year but the most effective combination of RSI-Currency
regarding generation of profit has been identified to be
Relative Strength Index (RSI) indicator for the period of ten years
RSI-EURUSD with considering the assumptions of this
(2001-2010) is presented in Figure 8.
study. RSI performed better with EURUSD as it could
survive till 30/10/2007 (Table 1).
 The other finding was that the total loss generated
by buying signals for all four traders is 6,903 pips however
sell signals generate 11,846 pips loss which the difference
is considerable. It shows RSI produces more profitable buy
signals than sell signals.
 One of the notable results generated from VHTS was
computing the amount of commission each trader has been
paid based on market rates. The commission paid is shown
in Table 1 indicating that brokers made profit regardless
of gaining or losing of traders.

ACKNOWLEDGE
The special thanks go to our advisor Dr. Arash Habibi Lashkari for
Figure 8: Final profit/loss with the employment of RSI Indicator for his guidance and advices in this project.
trading the four currencies within ten years (2001-2010)

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