Posted 26th March 2024

Gold and Silver Trading Strategies: RSI Explained

Gold

RSI: Key Takeaways

  • RSI is an analytical tool which measures the price momentum of market-traded assets.
  • RSI is one of the tools commonly used by technical analysts in trading gold and silver.
  • RSI is highly adaptable to a wide range of market conditions and trading types.
  • RSI is best paired with trend confirmation indicators within a trading strategy.

What is a Relative Strength Index (RSI) Indicator?

A Relative Strength Index (RSI) is a technical analytical tool which quantifies the price momentum of market-traded assets, such as silver or gold. As later detailed, this momentum is calculated using recent trading data on both the speed and magnitude of price changes.

Significant changes in, or levels of, momentum are often considered key lead indicators of market price action. A practical example of this is observed in a clock’s pendulum.  Here, momentum is zero at the top of the swing, reaches a maximum at the bottom, before returning to zero on the reverse swing.

When applied to gold and silver trading, an RSI can help assess whether a trader should be buying/going long or selling/going short these precious metals.

How to Calculate an RSI Indicator

For clarity, we shall consider the RSI calculation in two parts. Firstly, we look at the relative strength (RS) of price gains or losses over a specific trading period, thus:

Note that in the above, gains and losses can only take positive values and expressed in nominal, rather than percentage terms. The RS thus takes any value from zero (no gains and all losses) to infinity (all gains and no losses). By default, the total trading periods (X+1), is set to 14, but can be altered.

This formulation delivers an RSI which has a maximum value of 100 when RS is at infinity (all gains, no losses) and zero when RS is at zero (all losses, no gains). Indeed, the RSI is simple example of a broad set of range-bounded momentum indicators called oscillators.

How to Read RSI Indicator Charts

By default, an RSI reading above 70 suggests that the asset has excessive upward momentum, is overbought and is susceptible to some form of correction. This condition might suggest that selling or shorting the asset might be appropriate.

Conversely, an RSI reading below 30 is indicative of an oversold asset with excess downward momentum and poised for a recovery. This might suggest a trader buy or go long.

Virtually all trading and technical analysis platforms provide the current and historical default RSI calculation as a graphic output, while most allow further customisation of the default settings. RSI charts have a relatively low skill floor for initial interpretation, and for this reason, they are one of the most widely used technical analytical trading tools.

How to Use RSI Indicators

The RSI is a powerful tool that can help inform a trading strategy. However, no robustly successful strategy is based on one technical indicator. Rather, RSI should be viewed as a filter through which to evaluate trading conditions in conjunction with other technical indicators.

While the RSI can be useful in identifying overbought and oversold assets, it is prone to giving ‘false’ signals in strongly trending markets i.e. prompting traders to sell too early into a bullish trend and buy too early into a bearish trend. Augmenting the RSI with trend confirmation indicators is therefore a priority in non-ranging markets.

What is an RSI Indicator Trading Strategy?

Generically, a trading strategy is a system incorporating predefined rules and criteria that are used to make trading decisions. Indicators such as the RSI are particularly suitable for inclusion, as both inputs and outputs are hard, market-based data.   

Moreover, the RSI is highly flexible and can be calibrated to suit a wide range of trading strategies. The default ‘overbought’ and ‘oversold’ levels of 70 and 30 respectively can be modified to mitigate ‘false’ signals in certain markets by widening the bands to 80 and 20. Additionally, the trading period basis can range from days to minutes and the trading period window can be shortened from the default level of 14.  

Gold – and particularly silver – are relatively volatile assets over the short term, so might be amenable to RSI modifications, particularly if a shorter trading horizon is preferred. For instance, it is not unusual for a silver day trader to use a five or six-hour RSI to help inform a trading strategy.

As already mentioned, however, RSI performance alone is likely to be suboptimal, particularly in strongly trending markets. In these circumstances, the inclusion of other trend indicators such as moving averages, other oscillators, and/or chart patterns is likely to be beneficial. The number of possible combinations and permutations is vast, however, popular additions include Moving Average Convergence/Divergence (MACD), Bollinger Bands, Exponential Moving Averages (EMA), Livermore’s Pivotal Points and Average Directional Index (ADX). In any event, back-testing the performance of prospective strategies is highly recommended.

Benefits and Downsides of RSI Indicator Strategies

RSI can deliver several benefits within a trading strategy. It is relatively simple to calculate and understand. It is also readily available within trading platforms and technical analysis software. Its low-skill floor means that it is usually easy to interpret, and the RSI parameters are highly customisable to address different markets and accommodate a wide range of trading styles.

However, no trading tool is perfect, and the RSI is no exception. We have noted that it can perform poorly in strongly trending markets. Moreover, its default settings may require substantial modification and extensive experimentation to suit some trading strategies. Finally, as with any technical indicator, RSI requires other technical indicators to build a robustly successful trading strategy.

Citations

Mike is a market strategist and media commentator with 30 years of experience analysing precious metals markets. He developed his expertise working as an investment banker in emerging markets such as South Africa, Russia and Chile.

This publication is for informational purposes only and is not intended to be a solicitation, offering or recommendation of any security, commodity, derivative, investment management service or advisory service and is not commodity trading advice. This publication does not intend to provide investment, tax or legal advice on either a general or specific basis.

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