The Relative Strength Index is a popular crypto technical analysis indicator today. It is a favorite of many traders across several financial markets. So, it isn’t surprising that the RSI is a go-to oscillator for crypto price prediction.
In this article, we’ll explain this crypto oscillator, its formula, applications, benefits and how to use it for crypto price prediction. We’ll break things down as simply as possible. So, even if you’re a trading newbie or you’ve been trading for a while, you’ll find this article wholesome.
What is the Relative Strength Index (RSI)?
The Relative Strength Index (RSI) is a popular indicator used in different financial markets ranging from crypto to stocks and even forex. So, don’t be surprised when you see it used by traders in other markets.
This indicator was developed by J. Welles Wilder in 1978 and is used to predict price trends. The RSI is an oscillator or momentum indicator. Indicators like this are used to check how quickly the price of a cryptocurrency is moving and whether it is overbought or oversold.
Like most other oscillators, the RSI employs limits, sometimes visually represented by horizontal lines. Specifically, the RSI calculates the ratio of the average of upward price movements to the average of downward price movements over a specified period, typically 14 periods. It then normalizes this ratio to a scale between 0 and 100.
The RSI is a line that oscillates between this scale, that is, 0 and 100.
Typically, when the RSI line nears or crosses the upper limit (70), it’s been overbought, and its price will dump in the short run. On the other hand, when it trends near or goes below the 30 line, the cryptocurrency has likely been oversold, and you should buy the token. However, the market is neutral when it fluctuates within the 50 region, and the trend could move in any direction.
As helpful as the Relative Strength Index is, it’s not perfect. Price movements within its limits do not always indicate market sentiment, so it can be misleading when you rely solely on it for trading decisions.
For instance, cryptocurrencies often persist in overbought or oversold conditions for a long time, far exceeding the RSI’s limits. This can be disastrous to your strategy if you use the indicator alone.
We always suggest using the RSI and other oscillators in combination with other indicators, such as Bollinger Bands, and keeping an eye out for market news. With the Crypticorn Price Prediction Dashboard, you could do all of that from one place.
Benefits/Importance of RSI in Crypto Trading
The RSI is beneficial in crypto price prediction for several reasons. Primarily, it helps traders measure how quickly the value of a cryptocurrency or token is rising or falling. It can also help you determine appropriate entry and exit points, breakouts, etc. Let’s talk about them.
Determining Entry and Exit Points
The RSI is essential for buying and selling decisions in the crypto market. Knowing when a cryptocurrency is about to experience a trend reversal can be very useful as a trader. And spotting overbought and oversold conditions is a great way to identify them.
The RSI enables you to know the current trends in the market and set appropriate entry and exit points that may fetch you a profit.
Spotting Breakouts and Breakdowns
Breakouts and breakdowns are terms traders use to describe strong price movements in the market. When the price of a crypto asset significantly crosses its previous resistance level or the upper price band, it may continue to rise in price. This bullish trend is called a breakout, and it occurs when buying pressure overcomes selling pressure.
A breakdown is the opposite of this. It occurs when selling pressure has overcome buying pressure, and the price of a cryptocurrency continues to fall significantly below the support level or the RSI’s lower price limit. Breakdowns are usually a bearish signal, and it’s advisable to sell when this occurs, pending when a price reversal occurs.
Recognizing Divergence
The relative strength index is also helpful for spotting divergence, which occurs when a cryptocurrency’s price movement doesn’t agree with the direction of the technical indicator (in this case, the RSI).
By combining the MACD indicator with the RSI, you can spot when the price of a cryptocurrency is making lower lows than that of the indicator and vice versa.
While divergence seems scary, it’s an excellent opportunity for confirming trends and making important buying and selling decisions.
How to Calculate RSI?
The Relative Strength Index has a simple formula. But to use it, you must first determine a number of parameters, foremost of which is the trading period. We recommend using 14 periods (weeks, days, or hours), but you can adjust it based on your preference.
Also, you have to calculate the average gain and average loss over the specified period, which, in this case, is 14 days.
For each period within the 14 days, calculate the price change (gain or loss) compared to the previous period. If the price increases, that’s a gain; if it decreases, it’s a loss.
Specifically:
- Calculate the price change for each period: Do this by subtracting the current period’s closing price from the previous period’s closing price.
- Determine if it’s a gain or a loss: If the price change is positive (i.e., the closing price is higher than the previous closing price), it’s a gain. If the price change is negative (i.e., the closing price is lower than the last closing price), it’s a loss.
- Sum up the gains and losses: Add up all the gains and losses over the specified period.
- Calculate the average gain and average loss:
Once you have the total gains and losses over the specified period, calculate the average gain and average loss:
- Average gain: Divide the total gains by the number of periods. This gives you the average amount by which the price increased over the specified period.
- Average loss: Divide the total losses by the number of periods. This gives you the average price decrease over the specified period.
Once you’ve got your values, divide the average gain by the average loss. The result you get is called the Relative Strength (RS).
Once you have the Relative Strength (RS), you can then calculate the RSI.
RSI = 100 – (100 / [1+RS]).
Remember, RS or Relative Strength = Average Gain / Average Loss.
What do RSI values mean?
RSI values range from 0-100.
Overbought
When the RSI value is at or above 70, the cryptocurrency may be overbought, and a price reversal is likely due. This means you may profit from shorting or selling the token. Some traders tend to wait until the RSI value touches 80 before selling. It’s up to you to make that decision.
Oversold
An RSI value of 30, 20 or lower indicates a possible bullish trend. The crypto asset may likely be oversold, and the token’s price will rise soon, making for a great buying signal.
Conclusion
The RSI is an excellent indicator for crypto trading. It helps determine when a particular cryptocurrency has been bought or sold too many times, and a price reversal is in order. However, it can be misleading when used alone. So, combining it with other indicators, such as the MACD or Bollinger Bands, is best for a more objective view of the market.
FAQ
How do you use RSI in crypto trading?
You use RSI to examine overbought and oversold conditions in the crypto market. For instance, when the RSI value is above 70, the concerned token has likely been overbought, and a trend reversal will soon occur. On the other hand, RSI values of 30 and below are considered oversold.
What is a good RSI to buy?
RSI values of 30 and below are considered suitable to buy at in typical market conditions. This is because the cryptocurrency’s price has entered oversold conditions and may likely experience a bullish trend reversal.
What is the best RSI for crypto day trading?
Typically, most people use the default setting of 14 periods for their RSI. However, you would want a more sensitive index for day trading, so we recommend using a setting of 4.
