The Relative Strength Index (RSI) is a popular momentum-based technical indicator used to assess the speed and magnitude of price changes for a particular cryptocurrency or financial instrument.
- Type of Indicator: Momentum Oscillator
- Creator: J. Welles Wilder, Jr.
- When Created: 1978
- First Mentioned In: New Concepts in Technical Trading Systems
What Is The Relative Strength Index (RSI)?
The Relative Strength Index oscillates between 0 and 100, providing traders with a visual indication of overbought or oversold conditions in the market. The RSI helps identify potential trend reversals, entry and exit points, and the overall strength of the prevailing trend.
An asset is typically considered overbought when the RSI is above 70. Such readings may indicate the end of an uptrend or that a potential price decline is coming. Conversely, an asset is considered oversold when the RSI is below 30, potentially signaling a price increase is coming, or a downtrend is ending.
How Do You Read The Relative Strength Index?
The Relative Strength Index provides traders with valuable information about the momentum and potential reversal points in a market.
When the RSI reaches extreme levels, it may suggest that a trend is weakening and that a reversal is likely. The RSI, like other momentum tools, is prone to divergence. A divergence occurs when price makes a new high or low, yet the RSI does not. Alternatively, the RSI can make a new high or low, yet price does not.
How Does The RSI Work?
The RSI calculates the average gain and average loss over a specified period (typically 14 periods). Then the result is normalized to a range between 0 and 100.
The RSI compares recent gains to recent losses in an attempt to determine if an asset is overbought or oversold. By identifying overbought and oversold conditions, traders can make better-informed decisions about when to enter or exit positions.
Readings of above 70 are typically considered overbought, while readings below 30 are oversold. Traders can, however, adjust this threshold to 80/20 for example. This can filter out less overbought or oversold signals considered to be noise.
The 50 mark on the RSI is also of importance. When price passes through the mid-point of the indicator, it can signal an increasingly strong movement. At this point, traders may choose to add to positions.
How Is The Relative Strength Index Calculated?
RSI = 100 – (100 / (1 + (Average Gain / Average Loss)))
How Do You Use The RSI?
Overbought/Oversold: Buy signals may be generated when the RSI falls below 30 (oversold), suggesting that the asset may be undervalued and due for a price increase. Sell signals may be generated when the RSI rises above 70 (overbought), indicating that the asset may be overvalued and due for a price decline.
Divergence: Bullish divergence occurs when the price makes a lower low, but the RSI makes a higher low. This may signal a potential trend reversal to the upside. Bearish divergence occurs when the price makes a higher high, but the RSI makes a lower high, potentially signaling a trend reversal to the downside.
Mid-Line Crossover: Passing through the mid-line on the RSI can also be used as a buy or sell signal. It can also work as an indication of when to add to existing buy or sell positions.
RSI trendlines: Traders can draw trendlines on the RSI chart to identify trendline breaks, which may signal potential trend reversals or confirmations.
RSI Swing Rejection: The preferred buy or sell signal using the RSI occurs when the indicator is returning from overbought or oversold conditions. The RSI then attempts to move back into overbought or oversold territory, but fails to pass 70 or 30. Finally, the RSI then reverses setting a new high or low.
Additional Relative Strength Index Tips
Be cautious when relying solely on the RSI. It can generate false signals in certain market conditions, such as strong trending markets or volatile, choppy markets.
Adjust the RSI period length or overbought/oversold thresholds to suit your specific trading style and the asset you are analyzing. Shorter periods may generate more signals but may also be more prone to false signals.
Finally, practice using the Parabolic SAR on historical data, demo trading accounts, or TradingView before incorporating it into your live trading strategy.