What Is the Relative Strength Index (RSI)?
The relative strength index (RSI) is a momentum indicator used in technical analysis. RSI measures the speed and magnitude of a token's recent price changes to evaluate overvalued or undervalued conditions in the price of that token.
The RSI is displayed as an oscillator (a line graph) on a scale of zero to 100. The indicator was developed by J. Welles Wilder Jr. and introduced in his seminal 1978 book, New Concepts in Technical Trading Systems.
The RSI can do more than point to overbought and oversold tokens. It can also indicate tokens that may be primed for a trend reversal or corrective pullback in price. It can signal when to buy and sell. Traditionally, an RSI reading of 70 or above indicates an overbought situation. A reading of 30 or below indicates an oversold condition.
KEY TAKEAWAYS
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The relative strength index (RSI) is a popular momentum oscillator introduced in 1978.
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The RSI provides technical traders with signals about bullish and bearish price momentum, and it is often plotted beneath the graph of an asset’s price.
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An asset is usually considered overbought when the RSI is above 70 and oversold when it is below 30.
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The RSI line crossing below the overbought line or above oversold line is often seen by traders as a signal to buy or sell.
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The RSI works best in trading ranges rather than trending markets.
Image from CoinTR.pro BTC 1H 08/12/2022
Why Is RSI Important?
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Traders can use RSI to predict the price behavior of a security.
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It can help traders validate trends and trend reversals.
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It can point to overbought and oversold securities.
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It can provide short-term traders with buy and sell signals.
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It's a technical indicator that can be used with others to support trading strategies.
Using RSI With Trends
Modify RSI Levels to Fit Trends
The primary trend of the token is important to know to properly understand RSI readings. For example, well-known market technician Constance Brown, CMT, proposed that an oversold reading by the RSI in an uptrend is probably much higher than 30. Likewise, an overbought reading during a downtrend is much lower than 70.2
As you can see in the following chart, during a downtrend, the RSI peaks near 50 rather than 70. This could be seen by traders as more reliably signaling bearish conditions.
Many investors create a horizontal trendline between the levels of 30 and 70 when a strong trend is in place to better identify the overall trend and extremes.
On the other hand, modifying overbought or oversold RSI levels when the price of a stock or asset is in a long-term horizontal channel or trading range (rather than a strong upward or downward trend) is usually unnecessary.
The relative strength indicator is not as reliable in trending markets as it is in trading ranges. In fact, most traders understand that the signals given by the RSI in strong upward or downward trends often can be false.
Use Buy and Sell Signals That Fit Trends
A related concept focuses on trade signals and techniques that conform to the trend. In other words, using bullish signals primarily when the price is in a bullish trend and bearish signals primarily when a token is in a bearish trend may help traders avoid the false alarms that the RSI can generate in trending markets.
Overbought or Oversold
Generally, when the RSI indicator crosses 30 on the RSI chart, it is a bullish sign; when it crosses 70, it is a bearish sign. Put another way, one can interpret that RSI values of 70 or above indicate that a token is becoming overbought or overvalued. It may be primed for a trend reversal or corrective price pullback. An RSI reading of 30 or below indicates an oversold or undervalued condition.
Overbought refers to a token that trades at a price level above its true (or intrinsic) value. That means that it's priced above where it should be, according to technical or fundamental analysis practitioners. Traders who see indications that a token is overbought may expect a price correction or trend reversal. Therefore, they may sell the token.
The same idea applies to a token that technical indicators such as the relative strength index highlight as oversold. It can be seen as trading at a lower price than it should. Traders watching for just such an indication might expect a price correction or trend reversal and buy the tokens
Interpretation of RSI and RSI Ranges
During trends, the RSI readings may fall into a band or range. During an uptrend, the RSI tends to stay above 30 and should frequently hit 70. During a downtrend, it is rare to see the RSI exceed 70. The indicator frequently hits 30 or below.
These guidelines can help traders determine trend strength and spot potential reversals. For example, if the RSI can’t reach 70 on a number of consecutive price swings during an uptrend but drops below 30, the trend has weakened and could reverse lower.
The opposite is true for a downtrend. If the downtrend is unable to reach 30 or below and then rallies above 70, that downtrend has weakened and could reverse to the upside. Trend lines and moving averages are helpful technical tools to include when using the RSI in this way.
Example of RSI Divergences
An RSI divergence occurs when prices move in the opposite direction of the RSI. In other words, a chart might display a change in momentum before a corresponding change in price.
A bullish divergence occurs when the RSI displays an oversold reading followed by a higher low that appears with lower lows in the price. This may indicate rising bullish momentum, and a break above oversold territory could be used to trigger a new long position.
A bearish divergence occurs when the RSI creates an overbought reading followed by a lower high that appears with higher highs on the price.
As you can see in the following chart, a bullish divergence was identified when the RSI formed higher lows as the price formed lower lows. This was a valid signal, but divergences can be rare when a token is in a stable long-term trend. Using flexibly oversold or overbought readings will help identify more potential signals.
Image from CoinTR.pro BTC 1H 06/12/2022
Example of Positive-Negative RSI Reversals
An additional price-RSI relationship that traders look for is positive and negative RSI reversals. A positive RSI reversal may take place once the RSI reaches a low that is lower than its previous low at the same time that a security's price reaches a low that is higher than its previous low price. Traders would consider this formation a bullish sign and a buy signal.
Conversely, a negative RSI reversal may take place once the RSI reaches a high that is higher that its previous high at the same time that a token's price reaches a lower high. This formation would be a bearish sign and a sell signal.
Example of RSI Swing Rejections
Another trading technique examines RSI behavior when it is reemerging from overbought or oversold territory. This signal is called a bullish swing rejection and has four parts:
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The RSI falls into oversold territory.
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The RSI crosses back above 30.
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The RSI forms another dip without crossing back into oversold territory.
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The RSI then breaks its most recent high.
As you can see in the following chart, the RSI indicator was oversold, broke up through 30, and formed the rejection low that triggered the signal when it bounced higher. Using the RSI in this way is very similar to drawing trend lines on a price chart.
Image from CoinTR.pro BTC 1H 06/12/2022
There is a bearish version of the swing rejection signal that is a mirror image of the bullish version. A bearish swing rejection also has four parts:
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The RSI rises into overbought territory.
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The RSI crosses back below 70.
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The RSI forms another high without crossing back into overbought territory.
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The RSI then breaks its most recent low.
The following chart illustrates the bearish swing rejection signal. As with most trading techniques, this signal will be most reliable when it conforms to the prevailing long-term trend. Bearish signals during downward trends are less likely to generate false alarms.
Image from CoinTR.pro BTC 1H 06/12/2022
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