RSI Indicator Explained Crypto Trading Guide — CryptoDROI
Look Into the RSI Indicator Ultimate Guide.
Learn How to successfully use the RSI Indicator and Discover what RSI Divergence is. Get on the right side of trades that deliver you high returns at low risk. Use real-time RSI analysis to help you decide when to buy or sell.
The Relative Strength Index (RSI) is one of the most popular technical indicators in use. This oscillator measures the velocity and magnitude of directional price movements and helps traders determine when a market has reached overbought or oversold levels.
The RSI is an essential tool for cryptocurrency traders because it helps you find signals in the noise. You can find this indicator in a variety of markets, including the cryptocurrency market.
As a straightforward indicator, it is easy to understand and suited for beginners. That’s why you can see it integrated on every trading platform chart and in any crypto trading system.
The importance of technical analysis cannot be overemphasized in crypto trading. Anyone who wants to learn technical analysis will first learn two indicators: The Moving Average (MA) and the Relative Strength Index (RSI).
And one of the essential trading indicators used when analyzing a trade is the relative strength index. You can use the RSI indicator to measure the magnitude and duration of trends and identify potential reversal areas. Let’s find out more about it!
The relative strength index is typically used over 14 days and measures the speed and magnitude of directional price movements as the ratio of higher close to lower close.
This article explains how the RSI strategy works. As you read, you will understand how RSI divergence work, learn about the RSI signal, how to calculate it, and the benefits it offers.
What is the RSI Indicator?
The RSI is a technical indicator used in stock, futures, cryptocurrency, and commodity trading. J Welles Wilder developed the RSI indicator for the commodities market in the late 1970s. But over the years, it has proven to work very well for the crypto market too.
The Relative Strength Index (RSI) is a momentum oscillator that measures recent price changes’ magnitude (both speed and shift).
The RSI ranges from 0 and 100, and conventionally, people consider the price to be overbought when the RSI is above 70 and oversold when the RSI is below 30. Many systems generate trading ideas by looking for divergences and fluctuations in failures.
Below are the two RSI features that many traders use to trade:
- Bullish and Bearish Divergences.
- Overbought and Oversold Conditions (rules 30 and 70)
What is an RSI Divergence?
In simple words, divergence is a difference between indicators and price. The RSI divergence gives you the crypto trading edge you need to stay ahead of the crowd.
Divergences are essential trend reversal signals that result in a high probability of trade setups when combined with other indicators. A divergence pattern develops on the chart when the price action moves in one direction, and the signal moves in the other.
Crypto traders widely use the RSI indicator to identify divergence patterns.
For example, when you see the price action on the chart going up in an upward slope, while the RSI is going down in a downward slope. This structure is a negative divergence pattern or a bearish divergence pattern and indicates a possible trend reversal from top to bottom.
Likewise, when the price action goes down while the RSI indicator goes up, it shows the bullish divergence pattern.
Types of RSI Divergence
- RSI bearish divergence: Going with the general definition, when the price hits a higher high and the RSI hits a lower high, this condition is known as a bearish divergence, and it is good to be short (or exit if you are long) at this point.
- RSI bullish divergence: When the price hits a lower high, but the RSI is printing higher lows, this condition is known as a bullish divergence. It is advisable to take long positions (or close if you are short) at this time.
Overbought and Oversold RSI
The RSI is also known as the overbought and oversold indicator. The RSI is plotted at an index of 0 to 100, and 50 is the centerline. Readings above 70 are deemed overbought, while readings below 30 are considered to be oversold.
Despite that, these variables, oversold and overbought, would need to be confirmed with other indicators. Therefore, it is advisable to exit your old long positions (SELL) or look for short trades when the indicator shows you an overbought condition.
Conversely, any RSI movement below 30 is considered an oversold condition. Thus, it is advisable to exit your old short positions (if any) and look for long trades when the indicator shows you an oversold condition.
Importance of RSI Divergence
Why is RSI divergence is essential, and how to trade it?
The importance is usually noted by the big moves that occur after a fundamental divergence in price and the leading indicator. The most talked-about RSI Divergence, but there are many forms such as MACD Divergence, Price Volume Divergence, and just about any divergence between price and indicators.
When the prices move relative to an indicator, they can only be short-term and change depending on how the market moves. In a downtrend, the RSI divergence could mean that a breakout is coming and an uptrend will begin, but it would be easy for indicators to realign as the market moves forward, which would cost you time, profit, and a missed opportunity.
Divergence doesn’t happen very often, especially in chart frames for a few minutes. On a 30 minute chart, a reliable deviation can only occur once every few days.
The likelihood of a divergence occurring is greater at the end of the uptrend and downtrend, and they rarely happen in a sideways trend. It is best to find a peak or valley and look for divergences, indicating a market entry.
Even professional traders work hard to find a way to trade divergences with overwhelming precision. The best strategies only take positions at the top and bottom of the charts and follow candles for buy and sell signals.
Anytime you limit an indicator and strategize around it, you limit the number of trades you can make, but with the hope of securing a greater precision.
Acquiring discipline is essential for you to succeed at trading a divergence signal because it’s easy to get distracted in trading before complete divergence arises.
You should always let the trade go ahead before taking a position, but it can often be difficult to tell if the charts are truly diverging or just a short-term difference.
Differences Between Divergence and Reversal
A positive divergence is indicated when the RSI is higher on the chart, but the price is lower. However, a positive reversal is displayed when the RSI shows a lower low and printing a higher low.
Suppose you were to locate situations like this and analyze them. In that case, you might make the observation that positive discrepancies do not occur under the same circumstances, and you would be right. The same would happen with negative divergence and negative reversals.
Reversals are signaled when the trend is ready to resume. Divergences are reported when trends fade.
Statistical data shows that the intelligent trader knows how to look for negative reversals in a downtrend market and in an uptrend market to look for positive reversals.
Reversals are best traded because momentum matches the trend. Momentum creates trends. Then there are divergences in the countertrend, which makes them riskier to trade.
So, w hat exactly are reversals? Positive and negative reversals are signals that appear when price outperforms momentum, and you can use them to confirm the existing trend.
Being on the safe side of the trade is knowing when to join the trend, and that is what a reversal signal will tell you.
RSI Indicator Signals
If you knew where the market momentum would be, when it would happen, and in what direction it was heading, you would make a lot of profit. RSI locates momentum, using the 4 RSI signals,
The RSI indicator is a bit confusing for many crypto traders. Some do not understand the difference between divergence and a reversal of the Relative Strength Index indicator but don’t worry, keep reading, and it will become easy for you.
The relative strength index signals are often referred to as bullish or bearish reversals. They are the signals that generate momentum for all trades.
Even experienced traders using the RSI are unaware that there are reversals. If so, they don’t know which divergence pattern or inversion pattern is better.
Most of the indicators used in trading serve to determine if prices are overbought or oversold. This myth will lead to losing money or cause you to abuse the RSI or other momentum indicators.
Overbought and oversold are relative terms that make no sense with momentum. You will often read that you should sell when the RSI hits 70 on the scale and buy when it hits 30; this is not accurate in most cases and often is the complete opposite of what happens, so you should avoid it.
Reversals and divergences are the key signals to watch on the RSI indicator, and every trader should know what they are and when they form.
Below are the four RSI signals:
- Negative divergence (Bearish)
- Positive divergence (Bullish)
- Negative reversal (Only shows up in bearish trends)
- Positive reversal (Only shows up in bullish trends)
RSI Momentum
Gathering experience in trading over the years, I have realized about three types of RSI momentums. Anyone can identify two on the RSI charts, the third is more complex, but we can identify areas where the possibility and likelihood of this happening are higher.
Momentum Type 1
There are 4 RSI trading signals. Two of these signals are divergences. Today, many traders use divergence to confirm that a reversal is taking place on a price chart.
However, a trader who knows and understands where divergences occur knows that they appear when a trend has lost strength, and prices begin to retreat. Divergences are a signal to the trader in many cases that a trend is slowing down.
Momentum Type 2
RSI trading signals indicating Momentum Type 2 are reversals. There are also two. This type of momentum shows that momentum type 1 is running out, and prices are ready to try and continue the trend they were in before.
Therefore, reversals are a Type 2 Momentum signal used to search for entries to re-enter the trend.
Momentum Type 3
Type 3 is the momentum that traders try to capture when looking for chart patterns or price patterns.
It would be like cornering a wild bull, knowing all the time that when it decides to break free, it will do so with some force. Experienced cowboys are pretty good at knowing when this is happening.
Momentum Type 3 is the momentum that generates profit. But to do that, you have to be in position, and Momentum Type 1 and 2 help determine that.
The 4 RSI trading signals can allow you to profit from Momentum Type 3. To do this, you will need to educate yourself about the four signals and how they work.
Once you’ve done that, you can start choosing your Momentum Type 3 spots that generate substantial income.
Reading RSI Charts
Many traders, especially new ones, look at the charts and start to draw trend lines. Why? Because they learned how to do it through books, seminars, and websites. Without going into that, it is wrong.
Trendlines have no value except to tell you where the trend is coming from, not where it is going. You need methods of determining momentum because momentum is what makes a successful trade.
The RSI indicator using the four signals presents a clear picture of what is happening on any trading chart. You can do it manually or algorithmically using the paint indicator explicitly designed for TradingView so that you do not have to do this.
How to Calculate RSI
Popular trading platforms like TradingView have the RSI automatically incorporated, but we need to know the formula behind the calculation to understand how the indicator works.
Calculating the RSI is a two-step process, which includes measuring the relative strength of the price trend (RS) by comparing the average value of the price increase (gain) with the average value of the price fall (loss) for the chosen period.
The Relative Strength Index is a dynamic oscillator commonly used to predict an oversold or overbought business. The calculation process is simple:
- Look at the last 14 closing prices for a stock.
- Determine if the current day’s closing price is higher or lower than the day before.
- Calculate the average profit and loss for the last 14 days.
- Calculate the Relative Strength Index (RSI): (100–100 / (1 + RS))
- Calculate the relative strength (RS): (AvgGain/AvgLoss)
The basic RSI formula is below:
RSI = 100 — [100 / (1 + (average profit / average loss))]
The average profit or loss used in the above formula is the average gain or loss percentage over a retrospective period. RSI uses 14 days as the standard period to calculate its value. Anyone can change this setting.
The RSI will then be a value between 0 and 100. It’s widely believed that when the RSI is 30 or less, the stock is undervalued, and when it is 70 or more, it’s overvalued.
Benefits of using the RSI Indicator
The RSI indicator is one of the main tools for measuring the strength of the trend. This indicator can signal a trend reversal even before the price of an asset moves.
That is why it is better to use the RSI in a different trend. When the price moves in a horizontal channel, the RSI indicator is not helpful and often provides false signals.
The RSI can also help determine the trend. To take advantage of this feature, we need to enter an average value of 50 in the indicator. If the indicator readings fluctuate below the central value, we are in an ongoing downtrend, and if the renderings are above the main, we are dealing with an uptrend.
For example, here is a Bitcoin 4H chart from January 28 to February 22. Meanwhile, the cryptocurrency price has risen from around $ 31,000 to $ 57,000, and the RSI indicator has fluctuated above its average values.
An example of a downtrend can be seen between February 22 and March 1 when Bitcoin went from $56,000 to $43,000:
The RSI indicator also helps determine the trend or short-term reversal by using the overbought and oversold areas.
It’s pretty simple! If RSI falls on the 30 marks or below, there is a high probability that the asset will rise, and vice versa, the rise to the 70 marks or above indicates a possible decline in prices.
The hidden bullish divergence is also worth mentioning; it occurs when the price forms higher local lows, but the indicator continues to hit lower lows.
Sometimes a hidden bullish divergence forms against the backdrop of continued price growth; this means that it doesn’t even need to be preceded by a downtrend.
The RSI Indicator Restrictions
The RSI can move without showing a clear trend for an extended period.
False alarms have been a problem for technical analysts. Unique reversal signals are challenging to identify, and many false positives can confuse the trader.
The RSI reliability is higher when it follows a long-term trend. Like many other technical indicators, its signals are most reliable when they correspond to the general price trend.
The RSI indicator can stay overbought or oversold for a long time when the directional momentum is strong. As a result, the RSI is best used in a market that goes back and forth between bullish and bearish waves.
How to Apply the RSI Indicator to Your Gunbot Strategy
With Gunbot, it is easy to place fully automated trades based on the relative strength index oscillator. You can use it as a confirming indicator, but you can also define your entry and exit strategies based on the RSI.
The online crypto trading bot automates trading strategies for you and efficiently empowers investors of all experience levels with algorithmic trading strategies.
The RSI is part of the Gunbot arsenal of confirming indicators which you can use as extra confirmation for your trading setups. Do you know you can use the RSI oscillator as a BUY signal too?
Here’s how to do it! Click on the “strategies” tab on Gunbot GUI and create a simple strategy using “GAIN” as your buy and sell method. After that, go to your newly created plan “Buy Settings” and set a negative value in the “Buy Level” box, for example, -100.
Set your desired gain percentage on the “Sell Settings” and go to the “Indicator” tab, there activate the RSI buy and sell boxes, define your buy and sell levels, and choose between “oscillator” or “cross” as your execution trigger under RSI method.
That’s it! Now, every time your conditions touch the charts, Gunbot will execute your commands.
Don’t forget to choose your risk management strategy to go along with this trading setup. Here are two articles to read if you need to decide between DCA or StopLoss with a sound risk vs. reward ratio.
Read: Gunbot Dollar-Cost Average Overview and Risk vs. Reward Explained for more info.
Gunbot is one of the top cryptocurrency trading bots that you can find in the market today. You can use it to start trading or to help optimize your trading strategies.
Besides the basic features of automatic trading, users can also access backtesting, Tradingview alerts, arbitrage, a market maker for margin and futures trading, and more…
Conclusion
As the name suggests, any indicator “INDICATES” the price and does not dictate the price. RSI is no exception. Price changes will cause the RSI levels to move and not the other way around.
Indicators are undoubtedly helpful for beginners and algorithm traders. For beginners, indicators help avoid unnecessary trading, and algorithm traders use them to develop sound trading systems.
Once you know how to plot divergences and reversals and trade using statistical data highlighting the best RSI levels, the best times to trade, and when each signal needs to be dealt, you will begin to elevate your trading skills to a whole new level.
But, if you want to cut the learning curve and start using professionally developed crypto trading strategies based on technical indicators signals such as the RSI Indicator, you have to catch Gunbot now!
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Originally published at https://cryptodroi.com on August 9, 2021.
