The Relative Strength Index (RSI) is a technical indicator used to measure the short-term price momentum of a particular cryptocurrency’s market. It analyzes the asset’s recent trading performance by measuring the speed and direction of its recent price movement.
RSI is considered to be one of the most popular tools to help traders time their trades and identify swing trading opportunities in the market.
In this article, we will be looking at what the RSI is, how to read it on a price chart, and how to calculate the RSI of a cryptocurrency to evaluate its future market price.
So without further ado, let’s get started.
What Is Relative Strength Index (RSI)?
RSI can be defined as a momentum indicator used in technical price analysis. The index measures the speed and magnitude of a crypto token’s recent price change to evaluate whether the asset is overvalued or undervalued.
Apart from pointing out overbought and oversold securities, RSI can also indicate if the securities are primed for a trend reversal or correction in price, signaling traders when to buy and sell the asset.
The RSI is displayed as an oscillator in a line graph on a scale of zero to 100, where a reading of 70 or above indicates an overbought position while a reading of 30 or below indicates an oversold position.
How To Read The RSI?
The RSI of a cryptocurrency is given as a percentage value that moves between zero and 100. Usually, traders look at the RSI plotted on a graph under the asset’s price. There are two parallel lines on a price chart that show a channel with a line moving through it. These parallel lines indicate whether the market is oversold or overbought.
Traders view a cryptocurrency as oversold when it is facing persistent sell pressure and the RSI indicates that it is set to rally towards the upside. On the other hand, a cryptocurrency is seen as overbought when it has been heavily purchased and the RSI shows that it is due for a downward price correction.
While the technical indicator helps you analyze the historic price changes for a particular crypto asset, it is more useful to analyze the RSI of a token over a period of a few weeks.
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When Is The Market Overbought And Oversold?
A cryptocurrency is considered to be overbought when it trades at a price level above its true value, meaning the token is priced more than it should be. When traders see that a security is in an overbought position, they sell the asset expecting a price correction or trend reversal to the downside.
Whereas, a cryptocurrency is considered oversold if it is trading at a lower price than its true value. Traders purchase a crypto if it is in an oversold position fully expecting a price correction or trend reversal to the upside.
How To Calculate RSI?
Calculating the RSI involves using a complex mathematical formula to get the average price gained and lost by an asset over a given period of time.
Here is the formula:
RSI = 100 – [100 / (1 + (Average gain of n days the market closed / Average loss of n days the market closed)]
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How To Use The RSI When Trading Crypto?
- Entering and Exiting Your Trade
RSI informs traders when to buy a crypto low and sell high. Traders would wait till the RSI goes above 70 to exit their position, while they could wait until the indicator dips below 30 to enter the market.
- Swing Trading
This strategy of trading between short-term price rises and declines is another area where the RSI indicator is used to signal when to buy and sell an asset. Traders may buy a crypto token when the RSI crosses below 30 and sell when it crosses above 70, only to buy it back again once it goes below 30.
- Identify Support and Resistance Levels
The RSI can be used to identify key areas of support and resistance for a cryptocurrency before they are visible on the price chart. Support indicates the price the market is struggling to drop below and resistance is the price the market is struggling to break above.
- Bullish and Bearish Divergence
When the RSI of a cryptocurrency is in the oversold territory, then it has a bullish divergence. This could also be the case when the asset’s price is making higher lows and the RSI is making declining lows. Whereas, a bearish divergence occurs when the price is making higher highs and the RSI indicator is making lower highs.
Traders view a bullish RSI as a buy signal and a bearish RSI as a sell signal.
