What Is RSI and How Do You Apply It to Crypto Trading?
Relative strength index (RSI) is a momentum indicator that indicates overbought or oversold situations of an asset or cryptocurrency. Simply put, RSI is an oscillator that calculates high and low bands between two opposite values, while estimating the magnitude of price variation and the speed of these variations.
Due to the volatility of the stock and crypto markets, technical indicators provide a guide to plotting entry and exit points. Hence, RSI is a reliable indicator for crypto traders.
To find out more about the market’s sensitivity, some traders take it a notch higher by using Stochastic RSI. It is a technical indicator built through the combination of a stochastic oscillator formula and RSI, and ranges from 0 to 100. Want to know the best part? Read on to find out more.
What is RSI?
J. Welles Wilder Jr. first introduced RSI in 1978. Traditionally, RSI evaluates the change in crypto or stock asset price over a default 14-period time frame. However, the time frame can be extended or reduced to suit a trader’s investment horizon. It can be measured in weeks, days, hours, or even minutes.
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.Over at Bybit’s Trading page, you are able to add the RSI on the chart.
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.
RSI is the source of diverse trend trading strategies. One other common trading strategy is buying or selling when RSI hits the midline or crosses it. This depicts the start of a new trend.
When the RSI is above 50, a bullish trend is brewing. When it’s below 50, it’s the start of a bearish trend.
While using the midline cross-trading strategy, traders frequently use the ratios of 70/30, 50/50 or 60/40 as resistance and support in bullish or bearish trends.
When the resistance suffers a hit, a trend reversal may occur. Hence, traders should spring to action accordingly.
What is RSI Divergence?
In addition to its basic use, RSI divergence presents an arguably better market indication. Buying and selling on divergence offers you more assurance and a lower chance of reading signals incorrectly.
An RSI divergence reveals that the oscillator doesn’t agree with the present price movement. It points out the bearish and bullish positions.
A bullish divergence signal shows a lower low price action on the market chart and a contrasting higher low on RSI. This means the crypto asset is gaining momentum for an upward push. But for some reason, this isn’t apparent in the price movement yet.
On the other hand, a bearish divergence occurs when the chart is on a higher low while RSI is on a higher high. It’s a pointer to an upcoming price pullback.
What Does RSI Indicate?
An asset’s primary trend ensures an indicator’s signals are accurately read. RSI indicates the point where crypto hits a bullish trend and the bearish trend begins. As opposed to the general knowledge that 70/30 shows overbought and oversold assets, Constance “Connie” Brown, a market analyst, promotes a different position.
According to him, the oversold signal in an uptrend is most likely over 30% and the overbought signal is often above 70%. Hence, on a downward trend, RSI can be near 50% instead of the conventional 70%. For an improved identification of extremes, most traders engage horizontal trend lines.
However, one obvious way to avoid false RSI signals is via trading signals that correlate with the trend —for instance, using a bearish signal for an asset in a bearish trend, and a bullish signal for an asset in a bullish trend.
Quick Guide to Interpreting RSI
To highlight, once the RSI is above 30, it is an indication of a bullish trade signal. If it drops below 70, it’s a bearish signal.
So when a crypto RSI rallies above 70, it’s overbought and is most likely getting ready for a trend reversal. An RSI value of 30 or below shows an oversold signal.
In an uptrend, the RSI stays above 30 and frequently peaks to 70. In contrast to downtrends, RSI indicators go below 30 but never exceed 70. This simple guide helps to identify a trend’s strength and to note upcoming reversals.
For instance, if the RSI indicator fails to touch 70 during various price swings on an uptrend, yet drops below 30, the trend is weak and might retract lower.
On the other side of the spectrum, a downtrend is quite different. If it fails to fall to 30, or shoots above 70, the trend is weak. Therefore, it can retract upside.
The default time frame for RSI is 14 periods. This is because a myriad of traders (especially swing traders) find this time frame suitable. But most day traders often find it desirable to adjust for a more sensitive oscillator.
- Short-term day traders prefer periods between 9–11
- Long-term traders usually set periods from 20 –30
Either way, it all depends on the level of sensitivity needed.
RSI Swing Rejections in Crypto
RSI offers an opportunity to develop several trading techniques based on RSI indications. Swing rejection is one of these techniques, relying on the reaction of RSI to overbought or oversold signals. As with divergence, swing rejection is divided into bullish and bearish.
Bullish swing rejection is categorized into four different chains of movement:
- RSI triggers an overvalued signal
- It rallies back above 30
- It plunges into another dip, without hitting the oversold barrier
- RSI goes above its recent high
This technique is similar to applying a horizontal trend line to a price chart. In the chart below, the graphic representation of bullish swing rejection is vivid. After getting oversold, RSI pushes past 30% and hits a low rejection. This triggers the signal after it pushes higher.
The bearish swing rejection is similar to the bullish swing rejection. It also includes four major parts:
- RSI reaches the overbought territory
- It drops back below 70%
- It hits another peak, without sliding back into the overbought territory
- RSI finally breaks its recent low
Just like other trading techniques, this signal is dependable when it coincides with similar dominant long-term trends.
RSI vs. MACD
MACD is the short form of the moving average convergence divergence. Like RSI, it’s a momentum-based indicator that reveals the relationship between two changing average prices.
The formula for the MACD line is 26-period EMA (Exponential Moving Average) − 12-period EMA. After the MACD line calculation, a 9-day EMA “signal line” will be plotted on the MACD line. This serves as a trigger for buying and selling signals.
Traders and investors are free to buy when the MACD intersects above the signal line. Moreover, they can sell when the MACD intersects below the signal line.
RSI, on the other hand, depicts when a cryptocurrency is oversold or overvalued in connection with the latest price indication. To calculate the Relative Strength Index, divide the average price loss or gain by the definite time.
These two indicators are effective tools used by analysts to get a technical overview of the market movement. However, MACD evaluates the connection between two EMAs. RSI, on the flip side, measures price movements in connection with current price variations.
While these oscillators indicate momentum, they measure different aspects. Therefore, they frequently deliver contrasting indications. For instance, MACD may suggest that selling momentum is increasing for an asset.
Concurrently, RSI readings can be below 30% for an extended period, indicating the same asset is oversold.
Day Trade Crypto RSI and Bollinger Bands
RSI and Bollinger Bands (BBs) indicators are both used as top strategies for technical analysis. Frequently, investors combine both, as a dual strategy to better time entry and exit points.
On one end, RSI is a leading indicator that precedes future price actions. Bollinger Bands is a lagging indicator, i.e., the signal doesn’t get triggered unless something happens. So, the signal is based on activity.
Basically, Bollinger Bands strategy involves trading for reversals. As a rule of thumb, when a price touches the upper or lower band, it retracts, since that’s the extreme.
BBs has three constituents, as follows:
- 20-day moving average (the middle band)
- Upper band
- Lower band
The dual strategy of Bollinger Bands and day-trade crypto RSI requires looking out for when a price hits the lower band and gets oversold. This might be a perfect entry point.
The combination of the two strategies offers a more solid confirmation of market movements.
The Bottom Line
The Relative Strength Index is an effective tool for mapping out high probability entry points. However, for a better shot at accuracy, you can practice trading strategies on Bybit’s test account for a start.
And always remember that RSI isn’t a 100% guarantee. It would therefore be an added advantage to take on other technical analysis indicators.