The Relative Strength Index (RSI) is an indispensable tool in the arsenal of many investors. RSI identifies overbought or oversold conditions of an asset, providing market trend signals. In this article, we will explore the RSI calculation formula and how to use this indicator most effectively. Let’s find out with Crypto Trading right away
RSI calculation formula
RSI is usually calculated based on data from the last 14 days and uses closing prices for calculation. The formula for calculating RSI (Relative Strength Index) is calculated as follows:
RSI = 100 – (100/(1+RS))
Where, RS is relative strength, determined by:
RS = AG/AL
Components of the RSI formula:
- AG (Average Gain): Average of total gain periods in a given period.
- AL (Average Loss): Average of total loss periods in a given period.
Note that, RSI can only be calculated accurately when there is data from 14 days or more.
For example, let’s say the market closed higher 7 out of the last 14 days with an average gain of 1%. Over the remaining 7 days, the market closed down an average of -0.8%.
- RS = 1%/0.8% = 1,25
- RSI = 100 – (100/(1+1,25)) = 55.55
The RSI will change as the number and size of closes increase or decrease. If the market trend is strong, the RSI may have a value close to 100 or close to 0. When the RSI is close to 100, the market is overbought; when the RSI is close to 0, the market is oversold.
See more: What is so important about RSI that investors?
Understanding RSI Divergences
RSI Divergence is a phenomenon where the price moves in the opposite direction of the stochastic RSI indicator. This can signal a weakening of the current trend and an impending reversal in the cryptocurrency market.
There are two main types of RSI divergence:
- Bullish Divergence: Occurs when the price falls but the RSI rises. Indicates that the selling trend may be weakening and there is a potential for a bullish reversal.
- Bearish Divergence: Occurs when price increases but RSI decreases. Indicates that the buying trend may be weakening and a potential bearish reversal is possible.
How to use RSI divergence in Crypto trading:
- Use other technical indicators such as SMA, and MACD to determine the current trend of the market.
- Look at the price chart and RSI to see if there is a bullish divergence or bearish divergence occurring.
- RSI divergence is just a potential signal. Need to confirm with other factors like trading volume, market news, etc.
- Use stop-loss orders to limit risk in case of false signals.
Meaning of RSI indicator in technical analysis
RSI, short for “Relative Strength Index,” is important in the Crypto market. We use RSI to identify the price trend of an asset. When RSI is below 30, the asset is usually near the bottom, and when it is above 70, it is usually near the top.
In a downtrend, the RSI usually does not exceed 70 and often touches 30 or lower, and vice versa in an uptrend. Monitoring RSI helps investors determine the possibility of future price reversals. For example, when RSI fails to reach 70 after many price fluctuations, it can predict the weakening of the uptrend and the possibility of a reversal to the downside.
Applying the effective RSI calculation formula in crypto
The RSI formula is a popular technical analysis tool used to assess overbought and oversold levels. This formula is widely applied in a number of the following cases.
Method 1: Using RSI in combination with multiple time frames
The first method is to use the RSI indicator combining multiple time frames. We have to determine the price trend on the D1 chart and check whether it has entered the overbought or oversold zone.
- If the RSI is below 30, the market is considered oversold, and the trend can be judged from bearish to bullish. Therefore, buying is reasonable.
- Conversely, if RSI crosses 70, we can assume that the market is in overbought territory. Therefore, it is advisable to consider selling.
Next, we need to determine the entry point on the H4 frame. Simply wait for the price to enter the oversold zone on the H4 frame to buy and vice versa. If the price enters the overbought zone on the H4 frame, we will consider selling.
Method 2: Using RSI indicator to identify trends
In this method, we use trend recognition tools:
- First, identify the trend line on the large timeframe D1 (using the wedge pattern).
- Then, find a suitable entry point on the H4 frame. When RSI > 70 on H4, we open a Sell order.
Method 3: Use the RSI calculation formula combined with the SMA line
The RSI and SMA combination method is a popular trading strategy that uses two technical indicators to identify potential buy and sell points in the cryptocurrency market.
- When SMA 30 crosses SMA 100 and RSI crosses 50, buy.
- When SMA30 crosses down SMA 100 and RSI is below 30, sell.
- SMA 30 crosses down SMA 100 and RSI below 50, sell.
- When SMA 30 crosses SMA 100 or RSI goes above 70, exit sell.
Method 4: Using RSI in combination with Bollinger Bands indicator
Relative Strength Index (RSI) and Bollinger Bands (BB) to identify potential buy and sell points.
- When the price touches the lower band, the RSI shows an oversold signal.
- Conversely, when the price touches the upper band, the RSI shows an overbought signal.
Combining these two indicators creates a powerful signal filter, increasing the chances of success.
Method 5: Failure Swing
Investors only need to monitor the RSI index in the overbought and oversold zones to make trading decisions.
Wait for RSI to touch the overbought/oversold zone. Then wait for RSI to break out of this zone. Watch the movement and wait for RSI to break above the previous high and low to open the order.
Method 6: Using the RSI formula to trade divergence
This structure includes bullish divergence, bullish hidden divergence, bearish divergence, and bearish hidden divergence.
- Bullish divergence occurs when the price is trending down for a certain period. But RSI is rising, indicating strength.
- Bearish divergence occurs when the price is trending up in a cycle but the RSI is falling. Shows a sign of weakness.
- A hidden bullish divergence occurs when the new low is higher than the previous low. But the RSI has a higher previous low, showing the potential of an uptrend.
- Hidden bearish divergence occurs when the new high is lower than the previous high. However, the RSI has a lower previous high, indicating a risk of weakness.
See more: Instructions for opening an OKX exchange account
Limitations of the RSI indicator
RSI is a useful technical analysis tool but there are some limitations to be aware of when using it:
- RSI can generate false signals, especially in volatile markets or when trading volume is low. Therefore, it is not advisable to rely solely on RSI to make trading decisions but to combine it with other indicators and analysis methods such as Stoch RSI. You can learn more about What is stoch RSI to optimize profits and ineffective trading.
- Overbought (above 70) and oversold (below 30) RSI levels are indicative only and may change depending on market volatility and overall trend. For example, in a strong bull market, the RSI may reach 80 or higher without necessarily signaling an impending reversal.
- The default RSI setting (14 periods) may not be suitable for all markets. Therefore, it is necessary to adjust the RSI settings to suit your market and trading style.
- RSI is a lagging indicator, meaning it is based on past price data and does not accurately reflect current price movements. Therefore, RSI may not provide an accurate picture of current market conditions.
Conclude
The RSI index is a useful tool for investors to identify stocks with strong momentum in the market. To ensure an effective investment strategy, it is necessary to combine many technical analysis methods. In this way, investors can assess the potential of the transaction more comprehensively and accurately. We hope that the information about the RSI calculation formula has helped you better understand this tool and how to apply it in your investment process. Visit Crypto Trading now to update more useful information.
Frequently Asked Questions
What timeframes can RSI be applied to in crypto trading?
RSI calculation formula can be applied to any time frame, from minute charts to daily and weekly charts. However, the most popular time frame is 14 days.
How can RSI signal trend reversal?
RSI can signal a trend reversal when it reaches overbought or oversold levels, or when it creates divergence with price, that is, when price and RSI move in opposite directions.
How to combine RSI with other indicators in crypto trading?
RSI can be combined with other indicators such as Moving Averages, MACD (Moving Average Convergence Divergence), and Bollinger Bands to increase accuracy in technical analysis and determine market trends.
