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How to use RSI: Relative Strength Index – Crypto Trading Guide

The Relative Strength Index or RSI, is one of the most used indicators, both for beginners and advanced investors.

The RSI is an oscillator type indicator, so its value stays between 0 and 100. It measures the relative strength of upward and downward price movements to determine when an asset is overbought or oversold.

If the RSI score falls below 30 this tends to means that a coin is oversold, when the score rises above 70 it means that the coin is overbought.

Reading Oscillator Metrics

Let’s break down some of the technical detail to explain what the RSI score can tell investors.

The Oscillator behaves differently as the market moves through three distinct phases identified by Charles Dow: accumulation, mark up, and distribution.

Accumulation

After a crash, people feel insecure. They lose confidence in price and stop investing. Institutional investors or long term investors see the drop as a discount. Therefore, the price bounces between a support and a resistance entering at a range.

In this case, the oscillator tends to follow price movements, so if the price goes up, the oscillator tends to the overbought side and vice versa. During accumulation, the RSI score stays between 30 and 70 .

Mark up

After investors buy the dip, the price begins to rise again, amateur investors start to recover confidence in the coin and everyone starts to buy long positions — this trend causes the price to rocket to the moon. 

At this point, the RSI score rises above 70 frequently as price peaks, signaling that the coin is overbought.

Distribution

As the price reaches its peak and maximizes gains for initial investors, they start to sell their position creating downward price pressure. With price seemingly on the rise, novice investors become greedy and continue to buy. Once people realize that price is starting to fall panic selling begins and the price drops.

As price crashes and investors panic sell, the oscillator moves into the oversold area and dips below 30 frequently.

Calculating RSI

As you can see, the RSI is a pretty useful metric so let’s take a look at how it is calculated:

To calculate the RSI you have to apply two equations.

The first equation is used to obtain the relative strength (RS) value, which is the quotient of the moving average of “N” bullish periods by the moving average of “N” bearish periods, where the standard to be used is 14 periods. A period is one candlestick, so if you’re using 1h timeframe, 14 periods would be 14 hours.

Basically, the RS is found by averaging positive closing prices to obtain the value of the rising moving average.  You will have to repeat the previous step for the negative closing prices and then proceed with the division between these values to obtain the value of the initial relative strength (RS).

Once you have determined the value of RS, a second equation is used, which is the one that allows you to define the value of RSI, between 0 and 100. 

Equation No. 1: Initial relative strength (RS)

Equation No. 2: Relative Strength Index (RSI)

RSI Insights

The RSI indicator is versatile. It helps you predict what will happen to the price before it moves. However, conclusions you draw from this metric should be confirmed by price action, like price walls. Now, with this little disclaimer in mind, let’s talk about some insights.

Divergence

The RSI metric can help you identify periods of divergence.

A divergence happens when the price is moving in the opposite direction to the RSI and they can be useful for finding an opportunity to buy or sell a position.

There are two kinds of divergence: normal divergence and hidden divergence. RSI direction leads the future trend in normal divergence, while the hidden divergence is driven by price.

Normal divergence

Bullish DivergenceBearish Divergence
PriceLower lowsHigher highs
RSIHigher lowsLower highs

In the following example, RSI shows a downtrend while the price rises. Since this is a normal divergence, the oscillator predicts that the market is entering a bearish phase.

Here, we see higher highs on price and lower highs on the RSI score. After the price breaks the support level (orange line), the bearish reversal is confirmed.

Hidden Divergence

Bullish DivergenceBearish Divergence
PriceHigher lowsLower Highs
RSILower lowsLower lows

In the next example, RSI also shows a downtrend and price an uptrend. In this case, divergence is bullish for price because as price hits increasingly high lows, the oscillator score is hitting lower lows.

Here, we have higher lows on price and lower lows on the RSI score. After the price broke the resistance level, the movement confirmed to be a bullish divergence.

Final Thoughts

The RSI is easy to interpret making it one of the best technical indicators to use when getting started in cryptocurrency trading.

With the RSI score you can identify market trends, you can detect buy and sell signals, as well as knowing when an asset is overbought or oversold.

However, as with any other indicator, with this one, you can also get false trading signals. That’s why it’s so important to take other metrics into account and do price action when drawing conclusions.

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