At its core, the Relative Strength Index, or RSI is one of the popular tools for crypto traders, to measure the short-term market momentum. Using RSI, you can evaluate whether the crypto asset you are planning to trade is overbought or oversold. These calculations are made based on the recent price changes of the crypto asset, the speed with which these price changes are occurring, and the direction in which the asset is taking place on the charts.
What is the Relative Strength Index (RSI) Indicator?
Understanding the concept of relative strength and using RSI indicators is relevant for traders for several reasons. What exactly the traders should look for when planning their next trades and how the RSI indicators help them are stated below:
- The magnitude of Gains vs. Losses: RSI looks at the magnitude of recent gains and losses over a specified period (commonly 14 periods). By looking at the RSI indicators if the recent gains being made in a crypto asset are above 70, then this means that the asset is overbought and the probability is high that the price will drop for here soon. Conversely, if the losses made on a particular crypto asset are much higher than the gains, where the RSI value is typically below 30, then this shows that the asset is oversold and at the time undervalued. There are high chance that it will be due for a correction soon, so it presents traders the opportunity to buy it at a lower price and gain profits once the value of the asset rises above.
Comparison of Strength: RSI indicators also help traders confirm the strength of an existing trend. If a particular cryptocurrency is consistently showing RSI above 50, then it can be deduced that the cryptocurrency is in a strong uptrend position. If the RSI value remains consistently below 50 then it can be deduced that the cryptocurrency is in a downtrend. This shows the average gains or average losses being made on that particular cryptocurrency and they are then compared to assess the relative strength of the price movement. By getting these indicators, crypto traders can then formulate plans on whether they should buy or whether they should wait for the conditions to fall in the territory where they feel comfortable trading.
How to calculate the Relative Strength Index (RSI)?
The formula to calculate RSI is:
RS is the Relative Strength, calculated as the ratio of average gains to average losses over a specified period. The period in question is typically 14 periods. 14 periods can be considered as the last 14 trading sessions, which can be a 1-hour time frame, 4-hour time frame, 1-day time frame, or any of the preferred options that the trader wants to select.
Why is RSI an important tool for trading?
In cryptocurrency trading, you will not be able to survive for long if you don’t learn how to read and analyze charts. RSI Indicator is one of the many useful tools that help you make an informed decision when you decide to enter or exit a trade.
Plan an entry and exit for your trade: When the trader sees the RSI value of a particular crypto asset going above 70 then he knows that conditions are developing for that particular asset to start losing its value. If he doesn’t believe that in the long term, the asset might remain on its current trajectory or that he may find a better opportunity to exit now and buy it at a lower price later then he can exit from the trade. Similarly, if the trader sees that the RSI of a crypto asset is near or going below 30 then now is not the time to buy that cryptocurrency. When the price consolidates and the market stabilizes. Then he knows that he has a good chance to buy low and wait for the price to go up to sell high.
- Identify support and resistance levels: While the primary purpose of the Relative Strength Index (RSI) is not to identify support or resistance levels, it can provide some indirect assistance in this regard. If an asset is approaching a known support level, a rising RSI that crosses above 30 may suggest that conditions are becoming favorable for buying. This also means that the support level is strengthened. Conversely, if the asset is approaching a resistance level, a falling RSI that crosses below 70 may indicate that selling pressure is intensifying, adding weight to the resistance level.
- Swing Trading: Swing trading is one of the known approaches to doing crypto trading. In swing trading, traders take advantage of minor price fluctuations on the crypto chart. To make a well-timed buy or sell decision, traders rely on different indicators and RSI is one of them. For instance, a trader might choose to buy an asset when the RSI falls below 30, indicating it might be oversold and due for a potential price increase. Then, they may sell when the RSI climbs above 70, suggesting the asset is overbought and could experience a price correction. Swing traders can also profit from price declines by using short-selling techniques.
- Divergence and Reversal Signals: RSI can provide divergence signals, where the indicator’s direction differs from that of the price, potentially indicating an upcoming reversal.
Conclusion
Learning different analysis techniques is essential for every crypto trader, and investor in general. Remember that the crypto market is a very volatile market where prices change directions without a moment’s notice sometimes, so keeping yourself well informed in regards to how to anticipate the movement of the market and making plans accordingly are some of the vital qualities that every good trader should have.
These days every crypto exchange has charts along with the crypto asset listed on the exchange. On the charts along with other indicators, the RSI indicator is also displayed. This helps traders avoid doing mathematical calculations and jumping straight to other tasks involved in buying or selling decisions. Remember, while RSI is a very beneficial indicator to help you make trading decisions, you should not solely rely on it. Relying on a single indicator is not the most proficient way of carrying out trading activities, so you should always do your due diligence and take into consideration other factors before making your final decision.
