Relative Strength Index (RSI)

Despite its volatility factor, cryptocurrency trading can be a highly rewarding activity. With prices swinging wildly, crypto traders should always use effective tools to make informed decisions. One such tool is the Relative Strength Index (RSI), a popular technical indicator that can help traders gauge the momentum and potential direction of a crypto asset's price.

Below, you’ll find out more about the RSI, how it works, and how you can use it to your benefit in your cryptocurrency trading strategy.

What is The Relative Strength Index (RSI)?

The Relative Strength Index (RSI) is a momentum oscillator that measures the speed and change of price movements on a scale from 0 to 100.

First developed in 1978 by J. Welles Wilder Jr., this indicator is still widely used today to analyze and trade stocks, the foreign exchange market, and the highly volatile world of cryptocurrencies.

The RSI is an essential indicator for beginner traders, as it can help you identify overbought and oversold conditions, as well as potential trend reversals and divergences.

The RSI compares the average gain and average loss over a specified period of time, usually 14 periods.

How Does the RSI Work?

Based on a chosen time frame, the Relative Strength Index compares a security's strength on the days when prices increase to its strength on the days when prices are falling.

RSI is calculated using the following formula:

RSI = 100 - [100 / (1 + RS)]

Where:

RS (Relative Strength) = Average Gain / Average Loss

After this calculation, the RSI converts this relative strength into an index ranging from 0 to 100.

How to interpret RSI signals and levels?

RSI provides values ranging from 0 to 100, with specific levels indicating potential market conditions as follows:

• overbought (RSI above 70): when the RSI surpasses 70, it suggests that the asset may be overbought, and a price correction or reversal could be on the horizon; traders might take this as a signal to sell or take profits.
• oversold (RSI below 30): when the RSI falls below 30, it suggests that the asset may be oversold, indicating a potential buying opportunity; traders might consider buying or entering long positions.
• neutral (RSI between 30 and 70): an RSI reading between 30 and 70 is often considered neutral, indicating that there’s no extreme overbought or oversold condition; traders may use other technical or fundamental analysis tools in combination with RSI to make informed decisions.

Other helpful pointers on how to use RSI in crypto trading effectively:

1. spot divergence: if the price makes higher highs, but RSI makes lower highs (bearish divergence) or if the price makes lower lows, but RSI makes higher lows (bullish divergence), it indicates a potential trend reversal.
    
2. confirm with other indicators: it’s better to combine the Relative Strength Indicator with other technical indicators and analysis tools; using RSI in conjunction with moving averages, support and resistance levels, or trend lines can provide more robust trading signals.
    
3. adjust the period: depending on your trading style and the asset you're trading, you may want to adjust the period used in the RSI calculation; shorter periods (e.g., 14) are suitable for short-term trading, while longer periods may be more appropriate for longer-term investors.

How to Couple the RSI with Other Technical Indicators in Your Trading Strategy

RSI can be used in conjunction with other indicators and strategies to enhance its effectiveness and accuracy. Some of the most common combinations are:

RSI with Moving Averages

Moving averages are simple indicators that show the average price of an asset over a certain period of time. They can help smooth out the price fluctuations and identify the direction and strength of the trend.

By combining RSI with moving averages, you can filter out false signals and trade, and align with the trend. For example, you can use a 50-day moving average (MA) as a trend indicator, and only take long trades when the price is above the MA and the RSI is above 50, or only take short trades when the price is below the MA and the RSI is below 50.

RSI with Bollinger Bands

Bollinger Bands are volatility indicators that show a price’s standard deviation from its moving average. They consist of three lines: a middle band (usually a 20-day MA),  and an upper band and a lower band (both signaling deviations below the middle band).

Bollinger Bands measure the volatility and the range of the price movements, as also identify potential reversals and breakouts.

By combining RSI with Bollinger Bands, you can trade the extremes of the market and capture the swings. For example, you can buy when the price reaches the lower band and the RSI is below 30, or sell when the price reaches the upper band and the RSI is above 70.

RSI with MACD

MACD (Moving Average Convergence Divergence) is a trend-following and momentum indicator that shows the relationship between two moving averages of the price. This indicator covers two lines: a MACD line (the difference between a 12-day and a 26-day exponential MA), and a signal line (a 9-day exponential MA of the MACD line that triggers buying or selling signals).

The MACD indicator can help you determine a trend’s direction and strength, as well as potential trend changes and crossovers. By combining RSI with MACD, you can trade with the trend and avoid false signals. For example, you can buy when the MACD line crosses above the signal line and the RSI is above 50, or sell when the MACD line crosses below the signal line and the RSI is below 50.

Best Practices in Using The RSI Indicator Effectively

Here are some tips and best practices for using RSI effectively and improving your crypto trading results:

1. Use multiple time frames: daily, hourly, or 15-minute charts provide a broader perspective of the market trends and conditions, and more precise signals and entries. For example, you can use a longer time frame to identify the overall trend direction and strength, and a shorter time frame to spot overbought/oversold levels and divergences within a trend.
    
2. Use stop losses and take profits: use various methods to set your stop losses and take profits, like a fixed percentage or amount of your account balance or risk/reward ratio; a trailing stop that follows your price movements; or an indicator-based stop that uses RSI levels or other indicators to determine when to exit your trades.
    
3. Test your strategy: before using the  RSI in your live trading account, test your trading hypotheses on historical data or a demo account to see how it performs under different market conditions and scenarios; keep track of your results and performance metrics, like win rate or average profit/loss per trade to determine your strategy's effectiveness and profitability.

Conclusion

The Relative Strength Index is a powerful and versatile tool that can greatly help any crypto trader and investor in making informed decisions. Whether you are a novice or an experienced trader, mastering RSI is a valuable skill that can enhance your trading toolkit. By understanding its fundamentals and applying practical strategies, you can harness the full potential of RSI in your trading endeavors.

You can also rely on Altrady – an all-in-one crypto trading platform to make your crypto journey easier and less risky. If you want to start looking at and evaluating RSI signals, all you have to do is make an account, select an exchange, and enable the Relative Strength Index indicator.
With Altrady you can manage or trade assets over multiple exchanges using easy-to-use tools, so you can quickly analyze your portfolio growth.