The RSI indicator is one of the most popular technical indicators in Forex trading, and there have been thousands of systems developed using this popular yet effective formula. The indicator can also help crypto traders by providing overbought and oversold levels, which act as the main trading signals. RSI also works across different coins and assets overall, and crypto traders can use it on various timeframes from 1-minute to daily. In this compact guide, we will explain the RSI indicator without drawing on jargon and useless buzz. So, let’s begin.
So, what is the RSI?
The RSI indicator, just like other indicators, is a mathematical algorithm that follows the price and measures the strength of recent price moves on a scale from 0 to 100. The Relative Strength Index was developed by J. Welles Wilder Jr. It revolves around the concept called overbought and oversold conditions:
- Above 70 – Overbought condition, typically a sell signal
- Below 30 – Oversold condition, generally taken as a buy signal
However, RSI has two famous weaknesses: it is a lagging indicator and can produce many false signals in strongly trending markets. This lagging factor is derived from its inherent nature of being based on past price data. The indicator is a powerful tool to give clues about current market momentum, which can be very useful in fast-moving crypto markets.
How RSI works in crypto
The RSI indicator compares the size of recent gains to recent losses over a user-specified period, usually it is 14-period by default on the chart of your selected crypto coin. For example, on a 1-hour chart, it calculates the last 14 hours of price action to define whether the current market is overbought or oversold. When price rises more strongly than it falls, RSI rises, and when the market moves in bearish territory, RSI also drops. As a result, RSI moves between 0 and 100, showing the strength of a market’s momentum.
In crypto, prices typically swing widely, and RSI is a great way to get a quick read on whether the market is overheating or cooling down. Crypto traders love to use the RSI indicator to spot potential reversals or to confirm trends.
Reading RSI: Oversold, Overbought, Divergence
Apart from showing overbought and oversold levels, RSI is often used for its divergences, which typically give better quality signals. While most strategies use RSI for detecting overbought and oversold levels, smart traders use the indicator to spot divergences. There are bearish and bullish divergences. A bearish RSI divergence occurs when the price makes higher highs (uptrend), but the RSI starts making lower highs, indicating a possible reversal down. A bullish divergence, on the other hand, is when the price makes lower lows (is in a downtrend), but RSI makes higher lows, indicating a possible reversal up.
Sometimes RSI moves towards its 70 level, fails to break it, and then reverses, signaling momentum loss, and we traders call it a failed swing. The opposite is true when RSI falls near 30 and fails to go lower and reverses back up. This behavior gives traders important clues about price whereabouts and market sentiment.
How not to use RSI in crypto
One of the most widespread mistakes with RSI and other indicators is to use them as a standalone trading indicator. This is a bad idea because RSI, like other indicators, is lagging and tends to issue false signals, especially in strong trends. This is why it is crucial to confirm it with market context and longer-term trends. This is especially true for crypto markets, where coins can maintain bullish momentum for long periods. Just remember, when BTC was in a bull market, you would not want to short it even though RSI would issue many short signals as it dominantly was in overbought territory.
Another common mistake is to use the RSI indicators on very low time frames, like a 1-minute chart. The indicator tends to issue many false signals, and it is crucial to use other tools to filter noise and only pick high-quality setups.
The information presented in this article is for informational purposes only and should not be interpreted as investment advice. The cryptocurrency market is highly volatile and may involve significant risks. We recommend conducting your own analysis.
