In cryptocurrency technical analysis, few indicators hold as much respect and revere as the Relative Strength Index (RSI) – but what is the RSI and how can the RSI be used to trade?
The oscillating measurement tool is effectively a way to keep track of the momentum underpinning price actions.
Commonly used by traders as a signal of whether cryptocurrencies such as Bitcoin (BTC) have been oversold or overbought, the RSI uses a two step equation to quantify comparative gain/loss periods and produce a reading between 0-100.
RSI generally rises as the number and size of positive closes increase, and it will fall as the number and size of losses increase.
Traditional school of thought suggests that a digital asset is overbought (overvalued) when it has an RSI above 70, and similarly, when the RSI is sat under 30 this is typically an oversold (undervalued) signal.
How to trade using the RSI?
Typically, most traders consider the RSI to be a long-time frame (LTF) indicator that requires at least 14 days worth of data to be a meaningful measure, although the RSI can be used on a short-time frame (STF) basis for more immediate price moves.
The 14-day period is so established that it has become the standard default setting for the RSI indicator (known as RSI 14).
STF measures of RSI produce a much more extreme oscillation that produces many more overbought/oversold signals – this can be misleading to inexperienced traders – and the extreme volatility of STF price action in cryptocurrencies demands technicals to be used holistically alongside other components such as Bollinger bands, stochastic charts, moving averages etc.
Some traders prefer to limit the signals produced by the oscillator further by shifting the boundaries for the overbought signal to 80 and oversold to 20 – although this could mean they miss good opportunities to take positions.
Another key concept deployed by traders to use is the idea of divergence – traders look to see the price movements diverging in the opposite direction of the RSI as major signalling.
When the RSI falls from a high overbought signal, before the price starts to drop – this is known as bearish divergence and indicates a potential downward move.
When the RSI rises from a low oversold signal, before the price is rising – this is known as bullish divergence and indicates the strong potential for an uptick.
Read more: How institutional leverage will stabilise crypto volatility.
Disclaimer: The views and opinions expressed by the author should not be considered as financial advice. We do not give advice on financial products.