The Relative Strength Index or RSI is a commonly used technical indicator used in financial markets such as the cryptocurrency markets. It is used to assess the strength and momentum of price movements. Indicating when an asset is either overbought or oversold and thus are potential areas for an trend reversal.
An RSI is usually displayed as a line seperate from the usual chart. This can be seen in the image down below. The red circle on the chart indicates an overbought situation. This happens when the RSI indicator is above 70 on a scale from 0 to 100. An oversold situation happens when the RSI is below 30. In the image below we can see that the RSI indicator hasn’t fallen below 30 yet and thus there isn’t an oversold situation.
An RSI is typically calculated over a set period of time, often 14 periods. However, this can be adjusted to the traders liking. The RSI is calculated based on a simple formula which is:
RSI = 100 – [100 / (1 + RS)] where RS (Relative Strength) is the average gain divided by the average loss over a specific period.
Signals from the RSI
There are a couple of ways that the RSI indicator can provide assistance to traders. One being in the form of identifying the strength of a trend. In an uptrend, the RSI tends to stay above the 50 RSI level. This indicates that there is bullish momentum. On the other hand, in a downtrend the RSI tends to stay below the 50 RSI. Thus indicating a bearish momentum. Crossing the 50 RSI level is also significant. As it suggest a switch from bearish to bullish momentum or visa versa.
Another indication is divergence, in which the price of an asset and the RSI indicator move in opposite directions. Bullish divergence happens when the price makes lower lows while the RSI forms higher lows, indicating a potential reversal to the upside. Bearish divergence occurs when the price makes higher highs while the RSI forms lower highs, signaling a potential reversal to the downside.