What is RSI
Relative strength index (abbreviated RSI) or “relative strength index” is one of the indicators that are used in cryptocurrency trading. It belongs to the oscillator group. That means its main purpose: to measure price fluctuations.
RSI was first described by John Welles Wilder Junior in the late 1970s. This is the same author who described the ATR indicator.
The standard RSI is calculated over 14 days. But is not a direct instruction for action in trading. You can easily change it to whatever value you feel is appropriate. Some people prefer the shorter five-day RSI, while others will prefer the longer 25-day RSI. It all depends on your trading style.
So how do you calculate RSI?
Calculating RSI
Before calculating RSI, RS (relative strength) – relative strength – is calculated. For calculation it is necessary to know: how many days during the considered period of time the growth lasted and how many days the fall lasted. Next, the average price of growth and the average price of decline are calculated. In this case, the calculation can be different. Wilder himself preferred to use a smoothed moving average. However it is acceptable to use exponential as well. In a number of sources, one can find calculation of RS via simple average.
RSI itself is calculated using the following formula:
RSI = 100 – (100/(1+RS))
It’s worth noting that calculating RSI manually will only interest math fans. In real crypto asset trading, no one is going to do that. Almost any app or platform automatically calculates RSI.
So, we have calculated the Relative Strength Index. And how do you apply it to trading?
Oversold and overbought
RSI varies in the range from 0% to 100%. It is believed that if the indicator climbs into the zone above 70%, this or that asset will rise into the overbought zone. This means that the commodity is overpriced and a correction should begin soon. Accordingly, if RSI falls below 30%, we fall into the oversold zone. This indicates that the cryptocurrency is unduly undervalued and is a harbinger of growth soon.
Let’s look at a real-life example. From March 10 to April 16, ether showed good growth, adding more than 50% in value. That said, RSI warned crypto-enthusiasts back on April 14 that a trend change could be expected soon. It was on that day that the index entered an overbought zone. And starting on April 17, the picture changed completely and the airwaves began to decline.
Source: tradingview.com
Let’s look at the Avalanche chart as an example of oversold conditions. In 53 days, from April 18 to June 10, 2023, the AVAX token dropped in value by more than 53%. In June, the RSI heralded a change in market sentiment by coming into overbought territory. Within a month, AVAX had already added more than 50%, rising from $10.5 to $15.9.
Source: tradingview.com
It’s worth noting that the 30% and 70% levels are classics that Wilder suggested in the late 70s. In practice, things can be much more complicated. This is especially true in the cryptocurrency markets. For each specific instrument, you need to choose your own levels and see what kind of trading results you get.
Don’t think that levels should be equidistant, like Wilder’s, when levels are 30% away from the high and the low. You can use 85% for oversold, for example, and 20% for overbought. Here it all depends on your preferences and the behavior of the price.
But not only overbought and oversold traders search with RSI. There is also another important chart signal – divergence.
RSI divergence
In simple terms, it is a situation when the price and the indicator are divergent. There is a bullish divergence, when the price shows a new low, but the RSI stops falling, and bearish, when the value of the cryptocurrency shows a new high, but the relative strength index does not. By the name, you can understand that the first variation is a buy signal and the second is a sell signal.
For example, not so long ago a pure bearish divergence was observed in bitcoin. On July 13, BTC hit a new high, but RSI was below the June 23 levels that day. Thus, there was a divergence. Interestingly, the RSI also entered overbought territory on June 23, which added strength to the divergence.
Source: tradingview.com
We find a bullish divergence in the same bitcoin, only on the weekly chart. In June 2023, the RSI reached its low. Bitcoin price was falling until November, but the indicator started to rise. That is, a bullish divergence was formed. As we already know, bitcoin more than doubled after that.
Source: tradingview.com
It would seem that RSI is a great indicator: look for divergences, overbought and oversold. And you’ll make money. But not everything is so simple. The indicator has a number of drawbacks.
Disadvantages of RSI
RSI can be quite useless when there is a strong trend in cryptocurrency. For example, if the cryptocurrency starts a long boom, the indicator can quickly rise above 70% (or another level you set), indicating oversold. As a result, you will sell and the cryptocurrency will rise further.
The second disadvantage of RSI is that it doesn’t give clear entry and exit points. Basically, it is such a guessing indicator. You can see this from the example above. The divergence has been forming for almost five months. Not every trader has the nerve to stand that long. Particularly if someone went in with leverage.
Also, RSI should not be used to analyze prices alone. It is more effective in combination with other technical and fundamental analysis tools. It should be said that this cannot be fully attributed to disadvantages, as there are no indicators that would give 100% results.
To summarize: RSI is a technical analysis indicator from the group of oscillators. It can often provide signals about the changing situation in an individual cryptocurrency. However, it does not show exact entry points. The strongest RSI signals are: divergence, oversold and overbought.
This material and the information in it does not constitute personalized or other investment advice. Editorial opinion may not coincide with the opinions of the author, analytical portals and experts.