The Relative Strength Index (RSI) is a momentum indicator by which a trader can measure the recent changes in the market price of an asset. It helps the trader to identify whether the asset has been overbought or oversold in the current market conditions. This allows the trader to determine when is the right time for buying and selling. The whole exercise may sound easy, but requires a certain amount of analytical skills and experience to use it effectively.
The RSI is a mathematical equation applied on the basis of average gain and loss for a specified period of time. Usually, the RSI calculates the average of an asset’s price over 14 periods. This will vary as per the time frame selected like 14 days on the daily chart, 14 hours on hourly charts, and so on. The equation divides the average gain of the asset’s price by the average loss during the given period and then shows the value on a scale of 1-100.
RSI = 100 – 100 / (1 + RS)
RS = Average of X periods closes up / Average of X periods closes down
X = Usually will be 14 days, but can use any value of your choice.
The trading tools supporting RSI indicators will have an area where the number value of an asset’s current RSI is displayed. If the value is above 70, then the asset that a trader is planning to buy currently is overbought. It’s a situation of inflation and the asset should not be bought during this period. If the asset is already in the trader’s portfolio, then it’s a good time to sell as the market will not sustain the inflation for a long period and the prices are likely to drop soon. If the value is below 30, then the asset is oversold and is considered a good time to buy the asset.
The default setting of RSI is 14 periods, but a trader can choose to change the periods into a higher or lower value. Therefore the lower period will be more sensitive than the higher period. In such a trading setup, the RSI indicator will consider 80 as overbought and 20 as oversold.
USING RSI IN TRADING
RSI can be used to determine the macro trend of an asset. In a bear market, RSI tends to fluctuate between 10 and 60, with 50-60 acting as heavy resistance. In a bull market, RSI moves between 40 and 90 with 40-50 acting as strong support. To view these long-term trends on a chart, it’s best to use a weekly or monthly time frame.
You can use the RSI indicator to figure out when to buy or sell your cryptocurrencies. This index is basically telling you which assets are trading below or above their actual prices which the market wants to maintain. This powerful information to know, as you can see the deviation between the market price and the actual price. Above 70 is overbought and an asset below 30 is oversold, allowing investors to see which cryptos are going to face price corrections in the coming time intervals.
The higher an asset’s RSI goes above 70, the more overbought a coin or token is and that could mean the asset’s price will face a deeper pullback, the higher in percentage change it will drop. Once you spot these overbought conditions, it could be the ideal time for you to take profit on your position or maybe even close it entirely. Or if you are happy to be a risky trader, then you could always set up your short positions & try to make more profit on the way down.
You can also use the RSI as a signal for when an asset’s plummeting price might be reaching the point where it turns around. The lower the RSI goes below 30, the stronger the turnaround in price could be, the higher in percentage change it will rise. If you are able to spot oversold conditions, then you will be in a good place to predict when a coin or token is going to go on a strong rally, hence displaying you a clear buying opportunity.
It is advisable to use RSI with other trading indicators and have a clearer picture of the charts before making trading decisions. Using RSI with other indicators, price action analysis, and EMA strategies can form a strong foundation for further decision making.