Due to the volatility of the stock and crypto markets, technical indicators provide a guide to plotting entry and exit points. And when learning about technical analysis, it’s impossible to miss the Relative Strength Index indicator. Hence, RSI is a reliable indicator for crypto traders.
In this article, we will learn about the Relative Strength Index (RSI Crypto meaning), and why it is one of the most used momentum oscillators that exists. Interested to find that out? Continue reading!
RSI Crypto Meaning
The acronym RSI stands for Relative Strength Index, which is, in essence, a technical analysis (TA) indicator that measures the strength and velocity of price oscillations. As such, the RSI is a momentum oscillator that examines the magnitude and speed of the market movements.
When applied with standard settings, the RSI indicator takes into account the price of an asset over 14 periods. So if the indicator is applied to a candlestick chart, it would measure the price oscillations based on the previous 14 candles (i.e.,14 hours on hourly charts, 14 days on daily charts, and so forth). Technically, the RSI divides the average gain by the average loss and plots data on a 0-100 scale.
How Is RSI Calculated?
The formula for RSI is as follows:
RSI = 100 − [100/(1 + RS)]
RS = Average Gain/Average Loss
Average Gain = Sum of gain per period/time frame (e.g., 14)
Average Loss = Sum of loss per period/time frame
Trading platforms offer access to RSI and compute the values automatically. Hence, you don’t need to do the calculation. Once you apply it to your trade, the RSI line graph appears below your market charts.
How Is RSI Used?
RSI is commonly used to identify general market trends. The most elementary way of using the index is buying when an asset or cryptocurrency is oversold, and selling when it’s overbought. Generally, an asset is overbought when the RSI value is 70% or above, and oversold when the value is 30% or below.
When an asset is overbought, it’s a clear signal of a looming downtrend. On the flip side, oversold security is a sign of an incoming upward trend. In this case, the weakness of the asset is running out of steam and it’s gathering momentum to climb higher.
Another way of using the RSI indicator is trying to spot potential points of price reversal. To do so, traders look for the so-called bullish and bearish divergences. A bullish divergence happens when the RSI and the asset price move in opposite directions.
In other words, the market price makes a lower low, while the RSI makes a higher low. This suggests that, despite the price drop, the buying pressure is increasing. Conversely, a bearish divergence would indicate that the selling pressure is increasing, despite an increase in market price.
It is worth noting, though, that the signals created by the RSI indicator are not always accurate, so traders often combine it with other TA tools to reduce risks.
Understanding the RSI Indicator
1. The RSI can remain overbought and oversold for quite some time.
In bull markets, we see that Bitcoin often remains in overbought territory without any real relief, and in bear markets, the opposite. The RSI is a momentum oscillator that can be useful at pointing out and making obvious the periods in which the price has continued in one direction for an extended time.
However, these conditions are times when this would be the norm. For this reason, the RSI might be best used as a signal or warning that goes off for you to start paying attention to the trend and for other signs that it might be getting overextended in either direction. It is not somETHing that should be acted on immediately.
2. RSI dictates price action.
It is important to understand how the calculation and reading of the indicator relates to the price action you are seeing. If the price has been moving in a relatively tight range for a prolonged period of time, the RSI would likely be very neutral.
Therefore, any impulsive move that follows is going to act as an outlier and throw the indicator to one extreme. This could be the breakout that leads to continuation. You would not want to look at this as an oversold or overbought reading that is worth trading.
3. The RSI is best applied in its most suitable trading environment
Similar to moving average (MA) indicators, the RSI is best applied in its most suitable trading environment. For moving averages, these are trends. Meanwhile, the RSI is often best used in ranges where a drop-off in momentum at the extremes is one of the telltale signs of expected reversals.
Applying the RSI in a strong trending environment is one of the easiest ways to end up acting on false signals. It is quite common for traders to spot divergences in the RSI in a trending market.
What’s important to understand is that all trending markets are going to be filled with RSI divergences given the very normal periods of consolidation that occur after impulsive trends. These are always going to read as a divergence in momentum.
Is RSI Reliable?
RSI is among the most reliable indicators for both short-term and long-term trends. However, RSI tends to be more accurate when it conforms to or matches other long-term trend patterns.
A wise trader should use the RSI indicator on day/week charts to analyze previous price movements and derive conclusions about the current state of the market.
Closing Thoughts
The Relative Strength Index (RSI) indicator, like all price action – derived indicators, shows you what is already right in front of you. All you are seeing is a smoothed representation of the ongoing price action. Indicators make the finer details a bit more digestible and obvious.
What’s most important is that you understand RSI Crypto meaning and how the indicator is calculated. This way you are familiar with not only its strengths, but also its weaknesses. The RSI is an excellent tool, but like all other indicators, it can give a ton of false feedback.
Prior to using the RSI indicator, make sure to heavily backtest it and always record data around your trading performance.
