The RSI, or Relative Strength Index, is a popular technical analysis tool introduced in 1978. In the following article, Crypto Trading will provide details on the concept, formula, and how to use RSI to determine price trends. Follow along!
RSI Concept in Crypto Trading
In technical analysis, RSI (Relative Strength Index) is an important indicator in the momentum indicator group. When used properly and combined with other tools such as MA, Bollinger Bands, and MACD, it can be very effective.
RSI Indicator, or Relative Strength Index, measures the magnitude and speed of price movements. It is used to assess whether a market is overbought or oversold. The indicator is displayed as an oscillator chart with values ranging from 0 to 100.
RSI Indicator was developed by MR. J. Welles Wilder. It was introduced in the book “New Concepts in Technical Trading Systems” in 1978.
How is the RSI calculated?
The calculation is as follows: RSI = 100 – 100/(1 + RS)
In which: RS = Σ(price increase)/Σ(price decrease) – Average price increase/Average price decrease.
The average price increase and the average price decrease are calculated by taking the sum of the price increases and the price decreases over a specific period.
Meaning and role of RSI Indicator
As mentioned, this is a momentum indicator, which measures the speed of price movement.
Rising momentum indicates active buying in the market. While falling momentum is a sign that traders’ interest in the product is decreasing. RSI Indicator also helps to detect overbought or oversold conditions in the market.
The structure consists of two main parts:
- The RSI line moves between 0 and 100.
- Top border (default is 70) and bottom border (default is 30).
When the RSI is below 30, it indicates that the market is oversold. It may be nearing a bottom and prices will rise again. When it is above 70, it indicates that the market is overbought. It may be nearing a top and prices will fall.
By default, RSI is calculated throughout 14 periods. 14 days for daily charts, 14 hours for hourly charts, etc. You can adjust it to increase sensitivity (decrease periods) or decrease sensitivity (increase periods). For example, 7 days will be more sensitive than 21 days.
Additionally, short-term trading setups can adjust the overbought line down to 80. Or adjust the oversold line up to 20 (instead of 70 and 30) to limit inaccurate noise signals.
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How to read/understand the RSI indicator market in trading
To understand and apply the RSI indicator effectively in trading, you need to master how to read and analyze the signals it provides. Here is a detailed guide on how to use it to read the market:
Identify overbought/oversold price trends using the RSI indicator
The basic purpose of the RSI is to determine whether a product is overbought or oversold. When a product is overbought, it is trading above its intrinsic value. Conversely, when it is oversold, the product is trading at a low price and is likely to bounce back.
Simply put, when RSI crosses above the reference level of 30, it is a bullish sign. When it falls below the level of 70, it is a bearish sign.
When it moves above 70, the product is considered overbought and the price may fall. Conversely, when it falls below 30, the product is oversold and the price may rise.
However, these assumptions are only relative. Therefore, many traders often wait for a rise above 70 and then a fall before selling. Or a fall below 30 and then a rise before buying.
In an uptrend, it tends to stay above 30 and often touches 70. Conversely, in a downtrend, it rarely goes above 70 and is usually at 30 or below.
For example, in an uptrend, if the fails to reach 70 for several swings. Then it falls below 30, the trend may have weakened. It is likely to reverse to the downside. Conversely, in a downtrend, if the RSI fails to fall to 30 or below. Then it recovers to above 70, the downtrend may have weakened. It is likely to reverse to the upside.
How to identify RSI divergence?
In addition to identifying oversold and overbought conditions with levels 30 and 70, RSI can also predict trend reversals. Or identify support and resistance levels through divergence detection.
Divergence ( RSI Divergence) is a phenomenon where price and RSI move in opposite directions. For example, when the price increases and makes a new high that is higher than the previous high. But RSI decreases and makes a new high that is lower than the previous high. Or when the price decreases and makes a new low that is lower than the previous low. But it increases and makes a new low that is higher than the previous low.
These are the two most basic types of divergence signals in trading. In addition, other advanced divergence signals will be detailed in the trading method section below.
By using RSI along with some other indicators like Momentum, MA, and MACD, you can identify different types of divergences. Signaling price reversal trends: top divergence, bottom divergence, and hidden divergence.
Use the RSI Indicator to identify peak divergence levels
When the price makes a new high higher than the previous high but RSI also makes a new high lower than the previous high. This is a potential Short entry point.
If you look at the example in the chart when it touched the trendline at $12,000 again. The price dropped from $12,000 to below $10,000.
Applying RSI in coin trading for hidden divergence
Price trendline and RSI trendline are not in the same direction (except in divergence cases):
- The price is up but RSI is flat.
- Price is down but RSI is flat.
- Price is moving sideways but RSI is going down.
- The price is sideways but RSI is going up.
RSI Indicator and Bottom Divergence
When the price forms a new low lower than the old low it simultaneously forms a new low higher than the old low. This is a point that can be considered to open a long-term buy order.
Although this is a sensitive indicator tool. However, to ensure accuracy and reliability, you should combine it with other indicators such as MACD, Bollinger Bands, MA Line, support and resistance levels,… Along with the volume measure.
How to Use RSI to Identify Swing Rejections in Crypto Trading
Another signal that this indicator can provide is when it reverses from overbought or oversold territory. This signal is called “volatility rejection” and consists of the following four steps:
- fall into an oversold zone.
- back above 30.
- fell from the high to a new low but did not return to oversold territory.
- then increased and broke the recent high.
You can see more clearly through the chart below:
Similarly, the bearish “volatility denial” signal also consists of four steps:
- is rising and entering the overbought zone.
- drops below 70.
- rose from the bottom to a new high but it did not return to the overbought zone.
- then dropped and broke the recent low.
You can see more clearly through the following chart:
Instructions for trading with RSI indicator
To trade effectively with the indicator, you need to combine many factors. At the same time, you need to follow a clear trading strategy.
How to trade with RSI and Trendline?
Most simply and similar to using trendlines for price, you can wait and buy or sell at the 3rd or 4th point. This shows that waiting is extremely important.
Buy and wait: It is not always easy to spot a trendline. So you should look at different time frames. The trendline may not appear immediately on the H4 time frame. But on the H1 or H2 it can help you identify the 3rd and 4th points early to plan your trade.
Sell and wait: Remember that waiting is very important. Divergence signals can motivate you to enter a trade at the second point. However, when you first start using this method, we recommend focusing on the trendline. Wait for the 3rd or 4th point, whether it is up or down.
How to trade with triangle pattern with RSI indicator
This pattern is formed based on the use of trendlines of the RSI Indicator.
Generally, you should only predict a pattern when it is about 70% complete or more. This means that the trendlines have formed at least 3 or 4 price points. Predicting a pattern too early can lead to poor accuracy and cause you to cut your losses early.
To evaluate the RSI pattern, it is important to monitor the development of the trendlines. Determine whether the movement is consistent with the pattern. Especially when touching the trendline at the 3rd and 4th points in the later stages. Over time, the pattern will converge, and the contact points near the end of the trendline. This often leads to a breakout of the pattern.
See more: MEXC: Open a MEXC account, invest effectively
How do professional traders trade RSI parallel channels?
To use the RSI parallel channel pattern and predict temporary tops and bottoms. Traders should follow these steps:
Predicting temporary peaks using parallel channel models :
This is only effective for a certain time frame.
- Identify RSI Trendline. First, you need to identify an RSI Trendline that has formed from 2 or 3 points.
- Use the Parallels Channel tool. Use the parallel channel tool to draw a line parallel to the trendline and through the peaks between the two points above. Then, you need to observe the price reaction when it approaches and touches this parallel line.
Predicting a temporary bottom using the RSI parallel channel pattern :
Same as above, but to predict a temporary bottom.
- Identify RSI Trendline. First, you also need to identify an RSI Trendline that has been formed from 2 or 3 points.
- Using the Parallel Channel Tool: Use the parallel channel tool to draw a line parallel to the RSI trendline and pass through the lows between the two points above. Then, you need to observe the price reaction when it approaches and touches this parallel line.
This helps you predict temporary tops and bottoms in a given trend. However, it is important to note that this pattern is temporary in nature. It is only effective in a narrow time frame.
Instructions for installing RSI line in coin trading on the chart
To adjust the RSI indicator on the chart simply follow these steps:
Step 1: Open the chart of any Crypto coin and select the fx symbol.
Step 2: Search and select RSI or StochRSI in the list of indicators.
Step 3: Once the RSI or StochRSI indicator appears on the chart, adjust the default number of days (usually 14):
- Click on the RSI indicator.
- Select the item named “Settings” from the menu that appears.
Step 4: Enter the desired number of days in the box and press OK to save the changes.
- For example, if you want to track RSI for 7 days, enter 7 in the box and press OK.
This is a simple way to adjust the RSI settings on the chart. You can also track the indicator for the desired number of days.
Analysis of some common mistakes traders make when using RSI
For traders, using technical indicators is an indispensable part. However, you need to understand that each indicator has its meaning. If you do not understand it clearly, you can make mistakes when trading. With RSI, one of the biggest mistakes often occurs when entering an order right when there is an overbought or oversold signal.
Overbought signal entry usually occurs when RSI hits 70. However, the real overbought zone is between 70 and 100. If the price continues to rise sharply beyond 70 and reaches 75 – 80. Your sell order may be liquidated.
Similarly, with the oversold zone, when RSI drops below 30. There is no guarantee that your buy order will not be liquidated as the price may continue to drop further to 20 – 0.
For Holders
Some traders use RSI to find ideal buying points. For example, when RSI reaches overbought territory (70 – 80), they will wait until the indicator cools down before making a buying decision.
This is not wrong, but you need to consider what stage the market is in. In a strong bull market, waiting for it to cool down is often difficult. Because it can stay at high levels like 70 – 80, even close to 100 for 1 or 2 weeks.
Of course, it can’t stay at that level forever. There will be a correction at some point, and it will drop back to around 50 – 60. However, the reality is that the price at this level is no better than buying when it was at 70 a few weeks ago.
Worse still, if you wait for a while, but the RSI doesn’t go down. The price continues to rise. This is when the fear of missing out (FOMO) kicks in and takes over your trading decisions. It will push you into buying at the top.
Therefore, while the RSI Indicator can make traders lose their efforts, it can also make asset holders miss out on strong market gains if they hesitate to make timely decisions.
Conclude
Above, Crypto Trading has provided basic information about RSI. It can be said that the RSI index is a tool used by traders to track price fluctuations of products and other coins. Similar to other indicators, RSI also has certain limitations. Therefore, signals from RSI are often more reliable when they are confirmed to be consistent with long-term trends. Moreover, to increase the effectiveness of trading decisions, investors should also combine the use of other tools and indicators. Don’t forget to follow the website to get more news.
Frequently Asked Questions
What does RSI measure?
It is a measure of price volatility to determine whether an asset is overbought or oversold. It can also help predict reversal points in price trends.
What is the range of values for RSI?
This indicator ranges in value from 0 to 100. A value of 70 is generally considered overbought and a value of 30 is oversold.
How is RSI used in trading?
In trading, investors use it to determine buy and sell signals based on overbought and oversold levels. For example, when it goes above 70, it could be a sell signal. Conversely, when it goes below 30, it could be a buy signal.
