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Views: Technical analysis remains a key tool in making trading decisions by traders in the financial markets, as it allows for a deeper understanding of price dynamics. One of the most popular indicators in this area is the Relative Strength Index.
Relative Strength Index (RSI) - what it is
The Relative Strength Index (RSI) is a technical indicator that captures how quickly and significantly asset prices change. RSI values range from 0 to 100, thus making it possible to determine overbought and oversold levels in the market. Indicators over 70 indicate that the asset is overheated and this may portend a quick correction or trend change. Values below 30 signal oversold and indicate potential growth.
History of the Relative Strength Index
The RSI was introduced in 1978 by engineer Welles Wilder. In his landmark book “New Concepts in Technical Trading Systems”, he first mentioned this indicator as a tool to assess trend strength. Since then, RSI has gained wide popularity and has become an important part of analysis in financial markets. It is actively used both in traditional stock trading and in the markets of cryptocurrencies and other digital assets.
Relative Strength Index Calculation Formula
RSI is calculated using the following formula:
RSI = 100 - (100/ 1 + RS)
Where:
RS (Relative Strength) is the ratio of average positive and negative price changes over a certain period.
The standard value of the period is 14 days, and traders can change it depending on the strategy they are using.
Example of RSI calculation:
We choose a 14-day period.
Calculate the sum of all positive price changes and divide by 14.
Calculate the sum of all negative price changes (modulo) and divide by 14.
Calculate RS and substitute it into the formula.
Basic RSI trading signals
There are several basic RSI trading signals.
Crossing the 50 level
When the index exceeds the level of 50, it often indicates the strengthening of buyers in the market and indicates the continuation of the bullish trend. If the value of the indicator falls below 50, it indicates a probable transition of the market to a bearish trend and a decline in price
Divergence
It is formed when the indicator value and the asset price diverge, which often indicates a further trend reversal.
- A bullish divergence is formed when the price reaches a lower minimum than the RSI. This moment signals a possible easing of sellers' pressure and the probability of a reversal into longs.
- Bearish divergence is recognized when the price reaches a new high, unlike RSI, which remains significantly lower than the price. This condition is often a precursor to a price decline.
Overbought and oversold zones
RSI is applicable to the evaluation of an asset:
- A value above 70 demonstrates overbought, which increases the likelihood of a price correction.
- A value below 30 signals oversold, which can lead to an upward bounce.
Trend lines on the chart
The indicator is also widely used to draw trend lines. A breakdown of these lines signals a reversal of the current movement or the beginning of a new trend.
How to properly set up and use RSI
1. Adjustable RSI parameters
When the RSI indicator is integrated into a trading terminal (TradingView, MetaTrader, Binance), the trader has the ability to adjust several of the most important parameters:
- Calculation period: each parameter gives the trader a choice of the number of candles to calculate the RSI;
- Overbought and oversold boundary: the standard range is 70/30, however any level of overbought and oversold is available to the trader.
- Price Method: usually RSI is calculated using Closing Price, but sometimes other values;
- Smoothness: a smoothing parameter where a value equal to 0% deepens the RSI's fluctuation and reduces its sensitivity to small price fluctuations.
RSI period setting:
- Short period (5-9 candles): indicates quick reactions
- Long period (21-30 candles): considers signals slower.
14 is written as optimal because it is universal and fits most strategies;
2. Overbought and oversold levels
By default RSI uses the 70 and 30 boundaries:
- Sharp value > 70 corresponds to an overbought level, which affects a pullback and reversal;
- Sharp value < 30 is an oversold asset indicating potential upside.
Adjustment levels:
- 80/20 levels prevent excessive redundant signals and take away the sensitivity of the indicator;
- 60/40 levels are positioned as more sensitive and will be useful for active trend trading.
3. Prices for calculations
The indicator has a basic value of closing prices (Close), but it is possible to apply other values:
- Average price: based on all leading candlestick parameters;
- Median price: based on the maximum and minimum price values.
- Typical Price: helps to filter out market noise.
4. Additional RSI settings
The role and detail of the settings for changing the color, thickness of the RSI line for this analysis is important. It is also useful to specify the 50 level to make it clear which direction the trend is in:
- RSI above 50 indicates an uptrend
- RSI below 50 indicates a dominant downtrend.
5. Adapting RSI for different markets
- Forex: the setting is standard 14
- Stock market: the period is better up to 21
- Cryptocurrencies: volumes and volatility in the crypto market are high, so it is better to set RSI with a period of 7 and add 80/20 levels.
6. Using RSI in trading
- Filtering trades: for example, making long trades (long) when RSI value is below 30 or opening short trades (short) when RSI is above 70.
- Combining with other indicators: the result of using readings with other indicators like MACD, bollinger bands helps to increase the accuracy of entry.
- Divergences: this is one of the most reputable ways to reverse a trend.
Predicting a rise or fall in price
The principle of RSI in trend forecasting:
The value of the indicator is calculated based on the ratio of the rise and fall price for a certain number of candles (often 14). The indicator displays the value on a scale from 0 to 100, where:
- A value above 70 indicates an overbought asset and its likely price decline.
- A value below 30 indicates oversold and signals potential price growth.
- A value equal to 50 is considered neutral: RSI above 50, the trend is considered to be upward; if below, it is considered to be downward.
The main methods of analyzing RSI for price forecasting are:
1. overbought and oversold zone analysis
Example:
If the RSI for Bitcoin (BTC) reaches 75 but the price starts to slow down, it could indicate a loss of momentum and a possible decline. However, in strong trends, the RSI can remain in the overbought zone for an extended period of time, so it is important to be guided by additional trading data.
2. Crossing the 50 level
Example:
If Ethereum (ETH) is showing growth and the RSI crosses the 50 level upwards, this could signal rising demand and a continuation of the uptrend.
3. Divergences between RSI and price
Examples:
- Bullish divergence: the price of Bitcoin (BTC) falls to $90,000, but the RSI locks higher. This could be a signal of possible growth.
- Bearish divergence: the price of XRP reaches $1.2, but the RSI does not update the high. This is a signal of buyer weakness and further decline.
4. trend lines on RSI
Trend lines can be plotted on both the price chart and the indicator. This helps in identifying possible changes in market sentiment:
- Support line breakout: May signal a likely decline in price.
- Breakout of a resistance line: May indicate continued upward movement.
Example: If the RSI was in a downtrend and then broke through the resistance line to the upside, it may indicate a change in sentiment and an impending rise in the asset.
Adjust RSI to different market conditions:
The standard RSI levels (70 and 30) can be adjusted according to market conditions:
- Strong bullish trend: RSI may remain above 70 for a long time. Then it is advisable to use levels 80 and 40.
- Bear market: RSI can stay below 30 for a long time. Here it is better to use levels 60 and 20.
Example:
For volatile and liquid cryptocurrencies such as Solana (SOL), Dogecoin (DOGE), Shiba Inu (SHIBA), TRUMP, you can use 80/20 zones to minimize false and unnecessary signals.
Conclusion
RSI is quite a useful indicator for analyzing the state of the market and individual instruments on both the stock and cryptocurrency markets, but its signals are better confirmed by other indicators and based on your trading experience.
Frequently Asked Questions (FAQ)
1. How does RSI stand for?
RSI (Relative Strength Index) is an oscillator that analyzes the strength of the trend, as well as overbought and oversold zones.
2. How to set RSI?
5-7 - for intraday trading.
14 - standard indicator.
21-30 - for long-term and medium-term trading.
3. RSI above 70 - what does it mean?
Overbought signal, possible pullback.
4. RSI below 30 - should I buy?
Not always. You need additional confirmation.
5. What timeframe is better?
5-15 minutes - for scalping.
1-4 hours - for medium-term trading.
1 day - for investments.
